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Price setting in turbulent times. Survey evidence from Icelandic firms

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  • Thorvardur Tjörvi Ólafsson

    ()
    (Department of Economics and Business, Aarhus University, Denmark and Central Bank of Iceland)

  • Ásgerdur Pétursdóttir

    (University of New South Wales)

  • Karen Á. Vignisdóttir

    (Central Bank of Iceland)

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    Abstract

    This price setting survey among Icelandic firms aims to make two contributions to the literature. First, it studies price setting in an advanced economy within a more turbulent macroeconomic environment than has previously been done. The results indicate that price adjustments are to a larger extent driven by exchange rate fluctuations than in most other advanced countries. The median Icelandic firm reviews its prices every four months and changes them every six months. The main sources of price rigidity and the most commonly used price setting methods are the same as in most other countries. A second contribution to the literature is our analysis of the nexus between price setting and exchange rate movements, a topic that has attracted surprisingly limited attention in this survey-based literature. A novel aspect of our approach is to base our analysis on a categorisation of firms in the domestic market by their direct exposure to exchange rate movements captured by imported input costs as a share of total production costs. More exposed firms are found to be more likely to use state-dependent pricing, to adjust their prices in response to exchange rate changes, and to rely on increasing prices rather than decreasing costs to restore profit margins after an exchange rate depreciation. They also review their prices more often but nevertheless, surprisingly, have the same price change frequency as the median firm. On the other hand, price review frequency declines and time-dependent pricing increases as domestic labour costs rise relative to total production costs. The results provide important insight into inflation dynamics due to an interaction between high and asymmetric exchange rate pass-through and price indexation. This interaction causes an exchange rate depreciation to spread to sectors less exposed to such changes through the use of price indexation. Exchange rate pass-through, price indexation and backward-looking behaviour in price setting therefore pose challenges for monetary policy in Iceland.

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    Bibliographic Info

    Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2011-09.

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    Length: 49
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    Handle: RePEc:aah:aarhec:2011-09

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    Web page: http://www.econ.au.dk/afn/

    Related research

    Keywords: price setting; price stickiness; exchange rate pass-through; inflation dynamics;

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    References

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    1. Klenow, Peter J. & Malin, Benjamin A., 2010. "Microeconomic Evidence on Price-Setting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 6, pages 231-284 Elsevier.
    2. Alan S. Blinder, 1991. "Why are Prices Sticky? Preliminary Results from an Interview Study," NBER Working Papers 3646, National Bureau of Economic Research, Inc.
    3. Stahl, Harald, 2005. "Price setting in German manufacturing: new evidence from new survey data," Working Paper Series 0561, European Central Bank.
    4. Fabiani, Silvia & Loupias, Claire & Martins, Fernando & Sabbatini, Roberto (ed.), 2007. "Pricing Decisions in the Euro Area: How Firms Set Prices and Why," OUP Catalogue, Oxford University Press, number 9780195309287.
    5. Hall, Simon & Walsh, Mark & Yates, Anthony, 2000. "Are UK Companies' Prices Sticky?," Oxford Economic Papers, Oxford University Press, vol. 52(3), pages 425-46, July.
    6. Apel, Mikael & Friberg, Richard & Hallsten, Kerstin, 2001. "Micro Foundations of Macroeconomic Price Adjustment: Survey Evidence from Swedish Firms," Working Paper Series 128, Sveriges Riksbank (Central Bank of Sweden).
    7. Ali Choudhary & Thorlakur Karlsson & Gylfi Zoega, 2009. "Survey Evidence on Customer Markets," Birkbeck Working Papers in Economics and Finance 0916, Birkbeck, Department of Economics, Mathematics & Statistics.
    8. Mihai Copaciu & Florian Neagu & Horia Braun-Erdei, 2010. "Survey evidence on price-setting patterns of Romanian firms," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 31(2-3), pages 235-247.
    9. Fabiani, Silvia & Gattulli, Angela & Sabbatini, Roberto, 2004. "The pricing behaviour of Italian firms: new survey evidence on price stickiness," Working Paper Series 0333, European Central Bank.
    10. Filippo Altissimo & Michael Ehrmann & Frank Smets, 2006. "Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence," Occasional Paper Series 46, European Central Bank.
    11. Jósef Sigurdsson & Rannveig Sigurdardottir, 2011. "Evidence of Nominal Wage Rigidity and Wage Setting from Icelandic Microdata," Economics wp55, Department of Economics, Central bank of Iceland.
    12. Keeney, Mary J. & Lawless, Martina & Murphy, Alan, 2010. "How Do Firms Set Prices? Survey Evidence from Ireland," Research Technical Papers 7/RT/10, Central Bank of Ireland.
    13. Sheshinski, Eytan & Weiss, Yoram, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Wiley Blackwell, vol. 44(2), pages 287-303, June.
    14. Simon Hall & Mark Walsh & Anthony Yates, 1997. "How do UK companies set prices?," Bank of England working papers 67, Bank of England.
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