Lumpy Price Adjustments : A Microeconometric Analysis E. Dhyne (NBB, UMH), C. Fuss (NBB, ULB), H....

Lumpy Price Adjustments :

A Microeconometric Analysis

E. Dhyne (NBB, UMH), C. Fuss (NBB, ULB), H. Pesaran (Cambridge U., USC), P. Sevestre (U. Paris I, BdF)

The views expressed are those of the authors and do not necessarily reflect the views of the National Bank of Belgium and of the Banque de France.

"Price and Wage Rigidities in an Open Economy"National Bank of Belgium - Brussels, October 12-13, 2006

PP 2

Introduction

Empirical analysis of the sources of price stickiness:

nominal vs real rigidity

Motivation :

In modern macroeconomics, price rigidity = source of

short-run non neutrality of money

Degree of nominal rigidity One of the determinants of the slope of the NKPC

PP 3

Introduction

New strand of empirical work on the evaluation

of the frequency of consumer price changes

Similar set of stylized facts in industrialized countries

Price changes are infrequent

US : 25% Bils and Klenow (2004), Klenow and Kryvtsov (2005)

Euro area : 15% IPN, Dhyne et al. (2006)

Belgium : 17% Aucremanne and Dhyne (2004)

France : 19% Baudry et al. (2004)

Heterogeneity in price stickiness (oil products => services)

Asymmetry: 4 price changes out of 10 are price decreases

Price changes are relatively large (around 8 -10 %)

PP 4

Introduction

Main question : what’s behind infrequent price changes ?

A firm may consider that it’s more profitable to keep its price

constant between two periods because of

large price adjustment cost: nominal rigidity

small volatility of marginal costs / desired mark-up: real rigidity

Other questions :

Can prices be informative on the degree of "wage" stickiness ?

Are asymmetric price changes caused by asymmetric

price adjustment costs ?

PP 5

A canonical model of price adjustment

A firm i sets its price at time t based on pricing rule

pit = p*it if |p*it-pit-1| > cit

pit = pit-1 if |p*it-pit-1| ≤ cit

With p*it the (unobserved) optimal price given as

p*it = mcit + it = ft + i + it

Common componentof marginal cost and desired mark-up

Firm’s specific componentheterogeneity in price levels, ability of firm i to set its prices above/below ft

Idiosyncratic shockon marginal cost and desired mark-up

PP 6

Unobserved common component ft

Common movement in marginal costs and desired mark-up

Estimation by using cross-sectional averages : generalization

of Pesaran (2006) to non-linear models

where g(ft) non linear function of ft, pit-1 and other parameters

ft only equals to pt when E[cit] = c = 0

Iterative procedure : estimate ft given estimate given ft

Can also be estimated jointly with by ML

Both estimation procedures need N and T large

Summarize with AR(p): ;0 with ˆˆ

110 Nftf tt

K

kktkt

ttt fgpf~~

tf̂

PP 7

Sources of nominal and real rigidities

pit = pit-1 if |ft + i + it - pit-1| ≤ cit

= ft + i + it otherwise

Nominal rigidity :

Expected value of price adjustment cost cit, c

Real rigidity :

Unconditional volatility of ft, std(ft)

or volatility of the common shock,

Volatility of idiosyncratic shock it,

PP 8

The Belgian and French CPI data sets

Belgian CPI : around 10.000.000 individual prices

French CPI : around 13.000.000 individual prices

Prices observed at the retail level from 07/94 to 02/03

Described in Aucremmane and Dhyne (2004, 2005),

Baudry et al. (2004)

Estimation method : Maximum Likelihood with 1 firm

specific random effect (i)

98 products (Belgian CPI) / 30 products (French CPI)

PP 9

Price trajectories: Oranges (Belgium)

0

0.5

1

1.5

2

2.5

3

01/9

4

07/9

4

01/9

5

07/9

5

01/9

6

07/9

6

01/9

7

07/9

7

01/9

8

07/9

8

01/9

9

07/9

9

01/0

0

07/0

0

01/0

1

07/0

1

01/0

2

07/0

2

01/0

3

in E

UR

/Kg

PP 10

Price trajectories: Men socks (France)

0

2

4

6

8

10

12

01/9

4

07/9

4

01/9

5

07/9

5

01/9

6

07/9

6

01/9

7

07/9

7

01/9

8

07/9

8

01/9

9

07/9

9

01/0

0

07/0

0

01/0

1

07/0

1

01/0

2

07/0

2

01/0

3

in E

UR

PP 11

Ability of the estimated model to replicate the frequency and

size of price changes

Good results for 88 products for the Belgian CPI out of 98

Good results for a large set of products : flexible or sticky

prices, seasonal, with a trend, regulated or not

But bad performance for

products with few price quotes / month

products where cit highly volatile

Model's performance

PP 12

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

jan/94 jan/95 jan/96 jan/97 jan/98 jan/99 jan/00 jan/01 jan/02 jan/03

3.90

4.10

4.30

4.50

4.70

4.90

5.10

5.30

5.50

Estimated ft (Left axis) Log Price Index (Right axis)

True dataFreq = 0.730|Dp| = 0.073

Simulated dataFreq* = 0.747|Dp|* = 0.080

c = 0.025 = 0.036f = 0.063

Flexible prices : Heating oil

PP 13

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80


4.20

4.30

4.40

4.50

4.60

4.70

4.80

4.90

5.00


c = 0.079 = 0.159f = 0.040



Seasonal product : Oranges

PP 14

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60


4.45

4.50

4.55

4.60

4.65

4.70

4.75

4.80

4.85


c = 0.545 = 0.054f = 0.009



Asymmetric sticky prices : Special beer in a bar

PP 15

2.90

2.95

3.00

3.05

3.10

3.15

3.20


4.40

4.45

4.50

4.55

4.60

4.65

4.70


c = 0.727 = 0.134f = 0.007



Asymmetric sticky prices : Calculator

PP 16

Based on 88 Belgian CPI products + 30 French CPI products

Average c : ≈ 0.35,

comparable in magnitude with Levy et al. (1997)

based on cost structure of supermarkets.

Idiosyncratic shocks always larger than common shocks,

except for oil products (Golosov and Lucas, 2003)

Main results

PP 17

Oil products (Freq = 0.75) : small c (0.012), large ω (0.033),

small (0.027) → flexible

Perishable food (Freq = 0.24) : medium c (0.266),

large ω (0.028) and (0.098) → nominal rigidity

Non perishable food (Freq = 0.15) + non durable goods (Freq =

0.16) medium c (0.271 – 0.358), smaller ω (0.016 – 0.019) and

(0.076 – 0.086) → real and nominal rigidity

Durable goods (Freq = 0.08) + services (Freq = 0.06) :

high c (0.493 – 0.384), smaller ω (0.015 – 0.013) and

(0.079 – 0.054) → strong real and nominal rigidity

Sectoral heterogeneity

PP 18

Examples

Belgian CPI : Kiwis / Beef Sirloin : ≠ freq, ≈ c, ≠ ω, ≠

French CPI : Sugar / Men coat : ≈ freq, ≠ c, ≠ ω, ≠

Ratio (

ω)0.5/c

Kiwis Beef Sirloin Sugar Men coat

Freq 0.542 0.149 0.189 0.187

c 0.141 0.166 0.126 0.317

0.203 0.058 0.031 0.102

0.046 0.011 0.005 0.0370.011

0.058

0.166

0.149

Beef Sirloin

0.046

0.203

0.141

0.542

Kiwis

0.011

0.058

0.166

0.149

Beef Sirloin

0.046

0.203

0.141

0.542

Kiwis

0.005

0.031

0.126

0.189

Sugar

0.037

0.102

0.317

0.187

Men coat

0.005

0.031

0.126

0.189

Sugar

0.037

0.102

0.317

0.187

Men coat

Analyzing the frequency of price changes

PP 19

OLS regression of the frequency of price changes

(1) (2)

Const 0.216 0.140

DummyFrance -0.020 0.004

c -0.641 -0.402

1.411 1.074

3.004 0.998

(

)0.5/c

- 0.096

N 118 118

R² 0.693 0.901

Analyzing the frequency of price changes

PP 20

Can prices say something about wage rigidity? (Belgian CPI)

5 product categories for which price = labor cost

(hourly rate of a plumber, hourly rate of a painter, hourly rate in a

garage,

central heating repair tariff, domestic services)

Lowest frequency of price changes

Lower c than other services (0.3 compared to 0.5) but similar to

average perishable or non perishable food, non durable goods

Low magnitude of common and idiosyncratic shocks

→ real rigidity is a major source of “wage” price rigidity

Other results: tentative lessons on wage rigidity

PP 21

Exploring the asymmetry of price changes (Belgian CPI)

Stylized fact : price increases are slightly more common than

price decreases.

Is this associated to stronger downward nominal rigidities ?

Baseline model generates asymmetric price changes if ft characterized

by a positive (negative) trend (Ball and Mankiw,1994)

Estimation of a model of asymmetric price adjustment costs (cup, cdown)

for oranges (% ups = 52 %) and special beer in a bar (% ups = 88 %)

Results : cup - cdw statistically significant but not economically relevant

Oranges : cdw - cup = 0.000 Special beer : cdw - cup = -0.002

Other results: asymmetric price changes

PP 22

Comparable estimate of the magnitude of price adjustment costs with the

existing empirical litterature (Levy et al. (1997)) :

average level of c : close to 35% of the price level

Idiosyncratic shocks are larger than common shocks.

Heterogeneity in the frequency of price changes not only associated to

heterogeneity in price adjustment costs but also …

… significant contribution of real rigidity

Implications for macro models: heterogeneity in the degree of real rigidity

(Gertler and Leahy, 2006)

Conclusions

Lumpy Price Adjustments : A Microeconometric Analysis E. Dhyne (NBB, UMH), C. Fuss (NBB, ULB), H....

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