MENU COSTS AND THE NEUTRALITY OF MONEY price and wage decisions. These alternative models frequently assume a staggered pattern of timing(e. g, Akerlof [1969 Fischer [1977, Taylor 1980), and Blanchard [1983]) Money growth is subject to continuous shocks. The stochastic process governing monetary growth is taken as exogenous by all firms in the economy. Let M()denote the logarithm of the money supply at time t, where time is measured continuously We assume that the money supply process is increasing over time and does not ASSUMPTION 1. Monotonicity and Continuity. The money supply does not decrease over time, M(t2)2M(t,) for t2 2t1. Also, the money supply process is continuous in the time parameter t Normalize such that M(0)=0 The monotonicity assumption will rule out periods of deflation. The continuity assumption allows a simple characterization of firm pricing policies. The assumption also plays a role in analyzing the cross-sectional behavior of prices. This issue is taken up below.The monetary process is sufficiently general as to accommodate feed back rules. We shall consider particular examples of monetary es bel There is a continuum of firms in the economy indexed by i E [0, 1]. All firms face identical demand and cost conditions. The assumed microeconomic structure is based on the menu cost model of Sheshinski and Weiss [1977, 1983]. Let qi (t)and Q (t)represen firm i's nominal price and the aggregate price index, respectively with pi (t)and P(t)their respective logarithms. The aggregate price index, P(t), is derived endogenously below from individual firm prices. It is convenient to express firm is real price, q(t)/Q(t),in log form, ri (t), t)-ln[q(t)/?(t)], for all E [o, 1]. We take ri (O)as given The aggregate price index Q(t)is determined endogenously by aggregating individual firms' nominal prices qi(t). The index is assumed to depend only on the frequency distribution over nominal prices. Because firms have menu costs of price adjustment, prices may remain dispersed in the long run. Thus, the set of observed prices at any date may be described by a time-dependent frequency distribution function, say G (q). The index is assumed also to 2. In general, the money growth process may be set as a feedback rule basedMENU COSTS AND THE NEUTRaITY OF MONEY 705 price and wage decisions. These alternative models frequently assume a staggered pattern of timing (e.g., Akerlof [1969], Fischer [1977], Taylor [1980], and Blanchard [1983]). Money growth is subject to continuous shocks. The stochastic process governing monetary growth is taken as exogenous by all firms in the e~onomy.~ Let M(t) denote the logarithm of the money supply at time t, where time is measured continuously. We assume that the money supply process is increasing over time and does not make discrete jumps. ASSUMPTION1. Monotonicity and Continuity. The money supply does not decrease over time, M(t,) rM(t,) for t, 2 t,. Also, the money supply process is continuous in the time parameter t. Normalize such that M (0) = 0. The monotonicity assumption will rule out periods of deflation. The continuity assumption allows a simple characterization of firm pricing policies. The assumption also plays a role in analyzing the cross-sectional behavior of prices. This issue is taken up below. The monetary process is sufficiently general as to accommodate feed￾back rules. We shall consider particular examples of monetary processes below. There is a continuum of firms in the economy indexed by i E [0,1]. All firms face identical demand and cost conditions. The assumed microeconomic structure is based on the menu cost model of Sheshinski and Weiss [1977, 19831. Let qi(t) and Q(t) represent firm i's nominal price and the aggregate price index, respectively, with pi(t) and P(t) their respective logarithms. The aggregate price index, P(t), is derived endogenously below from individual firm prices. It is convenient to express firm i's real price, q(t)lQ(t), in log form, ri(t), for all i E [0,1]. We take ri(0) as given. The aggregate price index Q (t) is determined endogenously by aggregating individual firms' nominal prices qi(t). The index is assumed to depend only on the frequency distribution over nominal prices. Because firms have menu costs of price adjustment, prices may remain dispersed in the long run. Thus, the set of observed prices at any date may be described by a time-dependent frequency distribution function, say G,(q). The index is assumed also to 2. In general, the money growth process may be set as a feedback rule based on the history of output