Brookings Papers on Economic Activity, 1: 1988 for a plausible theory of rigidities. If rigidities exist, one of the following statements must be true: rigidities do not impose large costs on the economy; rigidities have large costs to the firms and workers who create them, but these are exceeded by the costs of reducing rigidities; or rigidities have small private costs, and so small frictions are sufficient to create them, but externalities from rigidity impose large costs on the economy. The problem with the first statement is the difficulty of explaining apparently costly events, such as rises in unemployment following monetary contractions, without nominal rigidities. The second seems implausible: it would not be costly for magazine publishers to print new prices every year rather than every four years, as they typically do. 2I Thus the third statement is the best hope for explaining rigidities What Are Menu Costs? Models of nominal rigidity depend on some cost of full flexibility, albeit a small one. The term menu cost may be misleading because the physical costs of printing menus and catalogs may not be the most important barriers to flexibility. Perhaps more important is the lost convenience of fixing prices in nominal terms-the cost of learning to think in real terms and of computing the nominal price changes corresponding to desired real price changes. More generally we can view infrequent revision of nominal prices as a rule of thumb that is more convenient than continuous revision. Thus, rather than referring to menus, we can state the central argument of recent papers as follows Firms take the convenient shortcut of infrequently reviewing and chang ing prices. The resulting profit loss is small, so firms have little incentive to eliminate the shortcut but externalities make the macroeconomic At a somewhat deeper level, we can interpret the convenience of fixing nominal rather than real prices as that of using the medium of exchange, dollars, as a unit of account. 22 Alternatively, following Akerlof and Yellen, we can view simple rules of thumb as arising from"ne 21. Stephen G. Cecchetti, The Frequency of Price Adjustment: A Study of the Newsstand Prices of Magazines, ' Journal of Econometrics, vol 31(August 1986), pp 255-74. The cost of reducing nominal wage rigidity may be significant if rigidity is reduce through shorter labor contracts, which require more frequent negotiations between unions and management. But wage rigidity can also be reduced through greater indexation or by having the nominal wage change more often over the life of a contract, neither of which appears to have large costs 22. Bennett T, McCallum, On 'Real and 'Sticky-Price Theories of the busine Cycle, "Journal of Money, Credit, and Banking, vol 18(November 1986), pp, 397-414