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Is a Calvo price setting model consistent with micro price data?

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Author Info

  • Luis J. Álvarez

    ()
    (Banco de España)

  • Pablo Burriel

    ()
    (Banco de España)

Abstract

This paper shows that the standard Calvo model clearly fails to account for the distribution of price durations found in micro data. We propose a novel price setting model that fully captures heterogeneity in individual pricing behavior. Specifically, we assume that there is a continuum of firms that set prices according to a Calvo mechanism, each of them with a possibly different price adjustment parameter. The model is estimated by maximum likelihood and closely matches individual consumer and producer price data. Incorporating estimated price setting rules into a standard DSGE model shows that fully accounting for pricing heterogeneity is crucial to understanding inflation and output dynamics. The standard calibration that assumes within sector homogeneity, as in Carvalho (2006), is at odds with micro data evidence and leads to a substantial distortion of estimates of the real impact of monetary policy.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/10/Fic/dt1010e.pdf
File Function: First version, April 2010
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1010.

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Length: 35 pages
Date of creation: Apr 2010
Date of revision:
Handle: RePEc:bde:wpaper:1010

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Related research

Keywords: price setting; Calvo model; heterogeneity; hazard rate;

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Heterogeneity and Calvo Pricing
    by Agent Continuum in Agent Continuum on 2010-04-19 16:20:59
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Cited by:
  1. Diego Romero-�vila & Carlos Usabiaga, 2012. "Disaggregate evidence on Spanish inflation persistence," Applied Economics, Taylor & Francis Journals, vol. 44(23), pages 3029-3046, August.

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