Nominal rigidities and economic fluctuations: The case of Puerto Rico

Abstract

This paper studies the importance and impact of price and wage rigidities on economic fluctuations in Puerto Rico. To this end, a DSGE model with nominal rigidities and monopolistic competition is estimated with macroeconomic data for Puerto Rico. Among the main results, it is estimated that over 79 percent of firms do not readjust their prices at any given period in Puerto Rico, a share that has, on average, been 14 percentage points higher than in the United States. Moreover, prices became more rigid after 2000 during the deflationary period of the recession. This constitutes evidence that firms rarely pass savings from cost reductions to consumers in Puerto Rico by reducing prices, and reduce prices less often, on average, than firms in the United States during periods of economic contraction (when prices would be expected to fall by more due to reduced demand). This has the effect of worsening the magnitude of economic recessions in Puerto Rico, as income falls for firms and individuals while costs remain constant.