Implicit contracts explain sticky rents and nominal rigidity

Continuing-tenant rents, which comprise over 90 percent of the CPI shelter component, exhibit extreme stickiness, often remaining unchanged for years.

This rigidity is puzzling, as typical US rental contracts are annual, and tenants face high moving costs, suggesting landlords have scope for increases.

Standard macroeconomic sticky-price theories, such as Calvo pricing or menu costs, fail to explain these patterns.

Hugh Montag and Randal J. Verbrugge propose an implicit-contracts theory where enforcement relies on renter frustration and endogenous departure following unexpected rent increases.

This mechanism, rather than reputation, prevents landlords from reneging on agreements.

The theory explains nominal rigidity: renters benefit from fixed nominal rents during inflation, removing incentives for inflation indexation.

This frustration also prevents inflation-based rent increases, as any hike would violate expectations and trigger departure.

The paper significantly advances the understanding of price stickiness in macroeconomics, providing a microfounded theory for rent rigidity that offers distinct implications for monetary policy transmission compared to traditional models like Calvo pricing.

It addresses shortcomings in existing theoretical work on rent stickiness, which often fails to explain the widening gap between continuing-tenant and new-tenant rents or the observed differences in rigidity across landlord types.

The authors introduce a novel enforcement mechanism for customer-firm relationships, setting their implicit contracts theory apart from those in labor economics.

Furthermore, the research connects to the growing literature on human imperfections in market interactions, highlighting how customer anger and pricing norms constrain firm pricing behavior.