Fair prices, sticky information, and the business cycle

A fair price model in which firms are hesitant to raise their prices due to concerns about adverse consumer reactions is developed and integrated into the standard New Keynesian framework. In the model, monetary neutrality arise as a combination of a fairness constraint putting a limit on how high prices can be set over households’ projections of firms’ marginal cost, and households’ limited ability to accurately observe marginal cost. I show analytically that the model is consistent with a plethora of outcomes, ranging from complete monetary neutrality to generating substantial real effects. When plausible values are assigned to parameters and prices are strategic complements, business cycle dynamics closely resembles that in the sticky information model proposed by Mankiw and Reis (2002).