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Aggregating Phillips curves

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Author Info
Jean Imbs () (Corresponding author: Department of Economics, Institute of Banking and Finance - HEC Lausanne, CH-1015 Lausanne, Switzerland.)
Eric Jondeau () (Institute of Banking and Finance, Ecole des HEC - University of Lausanne, Extranef 232, CH-1015 Lausanne, Switzerland.)
Florian Pelgrin () (Enseignement et recherche – HEC, Quartier UNIL-Dorigny, Bâtiment Extranef 246, CH-1015 Lausanne, Switzerland.)

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Abstract

The New Keynesian Phillips Curve is at the center of two raging empirical debates. First, how can purely forward looking pricing account for the observed persistence in aggregate inflation. Second, price-setting responds to movements in marginal costs, which should therefore be the driving force to observed inflation dynamics. This is not always the case in typical estimations. In this paper, we show how heterogeneity in pricing behavior is relevant to both questions. We detail the conditions under which imposing homogeneity results in overestimating a backward-looking component in (aggregate) inflation, and underestimating the importance of (aggregate) marginal costs for (aggregate) inflation. We provide intuition for the direction of these biases, and verify them in French data with information on prices and marginal costs at the industry level. We show that the apparent discrepancy in the estimated duration of nominal rigidities, as implied from aggregate or microeconomic data, can be fully attributable to a heterogeneity bias. JEL Classification: C10, C22, E31, E52.

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Paper provided by European Central Bank in its series Working Paper Series with number 785.

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Length: 60 pages
Date of creation: Jul 2007
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Handle: RePEc:ecb:ecbwps:20070785

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Keywords: New Keynesian Phillips Curve Heterogeneity Inflation Persistence Marginal Costs.

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  1. Emmanuel Dhyne & Catherine Fuss & M. Hashem Pesaran & Patrick Sevestre, 2007. "Lumpy Price Adjustments: A Microeconometric Analysis," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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