Background
The Taylor contract emerged as a model intended to explain price-setting behavior among firms. Named after economist John B. Taylor, the model is a key concept within New Keynesian economics, focusing on how prices are adjusted in a systematic yet staggered manner. This addresses nominal rigidity, where prices do not adjust instantly to changes in economic conditions.
Historical Context
John Taylor introduced the model in his work on wage rigidity and nominal rigidity. Initially applied to wage-setting by labor unions, the model was successfully generalized to understand price-setting actions by firms. The historical development of this concept has helped economists better analyze the microeconomic underpinnings of macroeconomic phenomena.
Definitions and Concepts
Nominal Rigidity
Nominal rigidity refers to the slow adjustment of nominal prices and wages to changes in economic conditions, leading to prolonged effects on real variables like output and employment.
Staggered Prices
Staggered prices describe a situation where not all firms adjust their prices simultaneously. Instead, price changes happen at different times across firms, leading to a distributed and more gradual overall price adjustment in the economy.
Major Analytical Frameworks
Classical Economics
Classical economics typically assumes flexible prices, where all prices adjust instantly to changes in supply and demand. Thus, nominal rigidity and concepts like the Taylor contract are not well-aligned with classical thought.
Neoclassical Economics
Similar to classical economics, the neoclassical framework also generally assumes price flexibility and thus has little to say about staggered price models.
Keynesian Economics
Keynesian economics does provide some foundational concepts that predate those formalized in New Keynesian models. The idea of nominal rigidities is critical for Keynesian interpretations but usually relies more on ad hoc explanations.
New Keynesian Economics
The Taylor contract fits directly into the New Keynesian framework, emphasizing microfoundations of price rigidity and its macroeconomic implications. Nominal rigidities introduced by staggered contracts help explain short-term non-neutralities of monetary policy.
Marxian Economics
Marxian economics typically does not focus on micro-level price setting; hence, the concept of Taylor contracts remains outside its usual scope of analysis.
Institutional Economics
While institutional economics might touch upon nominal rigidity, it generally does so through broader facets like labor laws and corporate settings rather than detailed models like the Taylor contract.
Behavioral Economics
Behavioral economics also addresses price setting but often through psychological and irrational factors, contrasting the formal logistic assumptions in the Taylor contract model.
Post-Keynesian Economics
Post-Keynesian economics diverges from New Keynesian, with more emphasis on historical and institutional factors, but still acknowledges price rigidities.
Austrian Economics
Austrian Economics places more emphasis on spontaneous order and less on structured respone mechanisms like those embodied in Taylor contracts.
Development Economics
In development economics, issues of price rigidity may arise but are often examined in broader structures involving market imperfections and external constraints.
Monetarism
Monetarism assumes price flexibility and seldom incorporates detailed price-setting models such as the Taylor contract within its analytical frameworks.
Comparative Analysis
Comparatively, the Taylor contract can be seen as a specific solution indicating persistence in economic cycles due to price-setting practices. Unlike models assuming perfect foresight or flexibility, Taylor contracts provide micro-founded interpretations consistent with observed economic inertia.
Case Studies
Potential case studies can include periods of observed monetary policy effectiveness, where staggered price adjustments slow the transmission of policy into economic activity, highlighting the role of nominal rigidity.
Suggested Books for Further Studies
- “Principles of Economics” by Greg Mankiw
- “Macro by Example” by Andrew B. Abel and Ben S. Bernanke
- “The Theory of Monetary Institutions” by Lawrence White
Related Terms with Definitions
- Calvo Contract: Another model of price rigidity, where each period, a constant fraction of prices are randomly reset.
- Nominal Rigidity: The resistance of nominal prices and wages to change despite shifts in supply and demand.
- Staggered Prices: An arrangement where firms do not adjust prices simultaneously, resulting in a gradual price movement.
