Julio Rotemberg, Distinguished Fellow 2016

Julio Rotemberg is a highly influential economist whose collective work has helped to lay the foundation for New Keynesian macroeconomics. Using both theoretical and empirical approaches, Rotemberg’s research has provided micro foundations for macroeconomic rigidities giving a role for monetary and fiscal policy to stabilize economic fluctuations. His influence can be appreciated in the way modern central banks conduct monetary policy.

One of Rotemberg’s most noteworthy papers is “Sticky Prices in the United States” (Journal of Political Economy 1982). Prior to this work, statistical models had shown that conditional on contemporaneous observables, lagged prices had predictive power for current prices at the firm, industry and aggregate levels. But there was no formal understanding of why firm prices were “sticky.”

Rotemberg filled the gap by proposing that firms face quadratic adjustment costs associated with price changes. Although he interpreted these as costs to the firm associated with price changes that would be upsetting to customers, his formulation can be extended to any cost firms face associated with changing their prices. By placing a quadratic cost on price adjustment, firms optimally choose to adjust prices slowly in response to firm level shocks.
These adjustment costs are the micro-foundation of price stickiness. The benefit of micro- founding price stickiness is that it created a series of model derived relationships that can be tested empirically. Taking his model to aggregate data, Rotemberg concluded that the hypothesis that prices adjust instantaneously is soundly rejected. Additionally, estimating the nature of the adjustment costs allows researchers to conduct counterfactual policies. Insights from Rotemberg’s paper formed the basis for the subsequent “menu costs models” that have dominated micro-founded models of price stickiness for the last four decades.

Rotemberg’s most significant work is “An Optimization-based Econometric Framework for the Evaluation of Monetary Policy” with Michael Woodford (NBER Macroeconomics Annual 1997). Rotemberg and Woodford develop an econometric approach to modeling the macro economy that provided the basis for the now standard Dynamic Structural General Equilibrium (DSGE) models used in both academic and policy arenas. The paper differed from the prior literature in that the authors set forth an econometric specification based on an explicit model of intertemporal optimization on the part of both households and firms. The Rotemberg-Woodford approach had two advantages over prior attempts to quantify the effects of monetary and fiscal policy interventions. First, by fully specifying the optimization decisions of households and firms, their methodology was immune to the well-known Lucas critique of econometric policy evaluation. Second, having a series of structural equations allows researchers to use existing micro estimates of model parameters to help discipline their econometric procedure. The impact of this paper cannot be understated. Subsequent researchers have expanded upon and refined their approach to incorporate even more realistic features of households and firms. All modern central banks have a version of a DSGE model that guides their policy decisions.

Rotemberg is also among the first to introduce monopolistic competition into models of macroeconomic fluctuations. Most prior business cycle models assumed perfect competition. These models had the implication that real wages were countercyclical, a fact that was at odds with both macro and micro data suggesting that real wages were (slightly) pro-cyclical. In “Markups and the Business Cycle” (NBER Macroeconomics Annual 1991) with Woodford, Rotemberg departed from the assumption of perfect competition. In doing so, the authors show that markups can endogenously move over the business cycle in ways that better match the data. During the past 30 years, considerable research has tried to better measure the cyclicality of mark-ups. Rotemberg is a pioneer in this literature. In addition to Rotemberg’s many papers tackling a diverse set of macroeconomic questions, he has also explored the behavioral aspects of price setting, the role of oil prices in macroeconomic fluctuations, and issues relevant to work place organizations.

Julio Rotemberg is currently the William Ziegler Professor of Business Administration at the Harvard Business School. Between 2002 and 2008, he was an editor of the Review of Economics and Statistics. He also edited NBER’s Macroeconomics Annual between 1993 and 1998. His Distinguished Fellow award recognizes that he is among the preeminent macro- economists of his generation through his many research contributions and their influence on the policy community.