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Does Indexation Bias the Estimated Frequency of Price Adjustment?

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Author Info
Maral Kichian
Oleksiy Kryvtsov

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Abstract

We assess the implications of price indexation for estimated frequency of price adjustment in sticky price models of business cycles. These models predominantly assume that non-reoptimized prices are indexed to lagged or average inflation. The assumption of price indexation adds tractability although it is not likely reflective of the price practices of firms at the micro level. Under indexation firms have less incentive to adjust their prices, which implies downward bias in the estimated frequency of price changes. To evaluate the bias, we generate data with Calvo-type models without indexation. The artificial data are then used to estimate the frequency of price changes with indexation. Considering different assumptions about the degree of price rigidity and the level of trend inflation in the data-generating model, we find that the estimated indexation bias can be substantial, ranging up to 12 quarters in some cases.

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Paper provided by Bank of Canada in its series Working Papers with number 07-15.

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Length: 30 pages
Date of creation: 2007
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Handle: RePEc:bca:bocawp:07-15

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Related research
Keywords: Inflation and prices Economic models Econometric and statistical methods

Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation

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  1. Mark Bils and Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
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  2. Martin Eichenbaum & Jonas D.M. Fisher, 2004. "Evaluating the Calvo Model of Sticky Prices," NBER Working Papers 10617, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March. [Downloadable!] (restricted)
    Other versions:
  4. Raf Wouters & Frank Smets, 2005. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE Approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 161-183. [Downloadable!]
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  5. Guido Ascari, 2004. "Staggered prices and trend inflation: some nuisances," Macroeconomics 0404029, EconWPA. [Downloadable!]
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  6. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October. [Downloadable!] (restricted)
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  7. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270. [Downloadable!] (restricted)
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  8. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July. [Downloadable!] (restricted)
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
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