Aggregation and Optimization with State-Dependent Pricing

The literature on the aggregation of (S,s) policies has generally ignored the impact of aggregates on individual decisions. In the case of pricing, the feedback effects are clear. Not only do pricing strategies determine the evolution of the price level, the evolution of the price level influences pricing strategies. The authors provide a consistent treatment of aggregation and optimization and study three issues in the pricing literature: the relationship between strategic complementarity and the real effects of money; the relationship between the variance of money and the correlation between money and output; and the relationship between the cost and size of price adjustment.