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Aggregating Phillips Curves

  • Jean Imbs

    (University of Lausanne, HEC and Swiss Finance Institute)

  • Eric Jondeau

    (University of Lausanne, HEC and Swiss Finance Institute)

  • Florian Pelgrin

    (University of Lausanne, HEC and CIRANO)

The New Keynesian Phillips Curve is at the center of two raging empirical debates. First,vhow 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 homogeneityresults 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.

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 07-06.

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Date of creation: Feb 2007
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Handle: RePEc:chf:rpseri:rp0706
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