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Inflation asymmetry, menu costs and aggregation bias – A further case for state dependent pricing

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Author Info

  • Péter Karádi

    ()
    (Magyar Nemzeti Bank)

  • Ádám Reiff

    ()
    (Magyar Nemzeti Bank)

Abstract

Asymmetric inflation response to aggregate shocks is an identifying macro-prediction of state dependent pricing models with trend inflation (Ball and Mankiw, 1994). The paper uses the natural experiment of symmetric value-added tax (VAT) changes in Hungary with highly asymmetric inflation responses to provide further evidence for state-dependent pricing and for the Ball-Mankiw conjecture. The paper shows, furthermore, that while a standard menu cost model like that of Golosov and Lucas (2007) underestimates the observed asymmetry, a model of multi-product firms that takes sectoral heterogeneity explicitly into consideration can quantitatively account for the inflation asymmetry observed in the data. This aggregation bias of the standard model is the result of the strong interaction term between trend inflation and menu costs in determining asymmetry in the model, and the positive correlation between sectoral inflation rates and menu costs in the data. The paper implies that the real effects of negative monetary shocks can be substantial even in the standard Golosov and Lucas (2007) model if these additional factors are taken into consideration.

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File URL: http://english.mnb.hu/Root/Dokumentumtar/ENMNB/Kiadvanyok/mnben_mnbfuzetek/mnben_WP_2010_3/wp_2010_3.pdf
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Bibliographic Info

Paper provided by Magyar Nemzeti Bank (the central bank of Hungary) in its series MNB Working Papers with number 2010/3.

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Length: 41 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:mnb:wpaper:2010/3

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Web page: http://www.mnb.hu/
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Related research

Keywords: aggregation bias; inflation asymmetry; menu cost; sectoral heterogeneity; value-added tax;

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References

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  1. Ellingsen, Tore & Friberg, Richard & Hassler, John, 2006. "Menu Costs and Asymmetric Price Adjustment," CEPR Discussion Papers 5749, C.E.P.R. Discussion Papers.
  2. Etienne Gagnon, 2006. "Price Setting during Low and High Inflation: Evidence from Mexico," 2006 Meeting Papers 300, Society for Economic Dynamics.
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Cited by:
  1. Etienne Gagnon & David López-Salido & Nicolas Vincent, 2012. "Individual Price Adjustment along the Extensive Margin," NBER Chapters, in: NBER Macroeconomics Annual 2012, Volume 27, pages 235-281 National Bureau of Economic Research, Inc.

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