Endogenous frequencies and large shocks: price setting in Greece during the crisis

We utilize a unique micro price data set for Greece that underpins the Greek CPI. It spans more than two decades, during which Greece suffered two large economic shock. We find that during these times there were significant changes in the pricing behavior of Greek firms. We find that macro-economic developments such as annual inflation and output growth are important factors in determining the frequency and size of price changes. This leads to an intertemporal inflation dynamic linking current inflation to future price behavior and inflation. Utilizing the empirical estimates from the data during the first large shock, we combine a Taylor rule and Euler equation with the inflation dynamic resulting from the asymmetric impact of inflation on the frequency of price increases and the frequency of price decreases. The results of the simulations capture the ‘out of sample’ Greek inflation developments well during the second shock. Finally, we show that during large shocks mispricing increases, which may lead to an overreaction of frequency developments.