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Refining Stylized Facts from Factor Models of Inflation

  • De Graeve, Ferre

    ()

    (Monetary Policy Department, Central Bank of Sweden)

  • Walentin, Karl

    ()

    (Monetary Policy Department, Central Bank of Sweden)

Factor models of disaggregate inflation indices suggest that sectoral shocks generate the bulk of sectoral inflation variance, but no persistence. Aggregate shocks, by contrast, are the root of sectoral inflation persistence, but have negligible relative variance. We show that simple factor models do not cope well with essential features of price data. In particular, sectoral inflation series are subject to features such as measurement error, sales and item substitutions. In factor models, these blow up the variance of sector-specific shocks, while reducing their persistence. We control for such effects by estimating a refined factor model and find that inflation variance is driven by both aggregate and sectoral shocks. Sectoral shocks, too, generate substantial inflation persistence. Both findings contrast with earlier evidence from factor models, but align well with recent micro evidence. Our results have implications for the foundations of price stickiness, and provide quantitative inputs for calibrating models with sectoral heterogeneity.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 254.

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Length: 41 pages
Date of creation: 01 Aug 2011
Date of revision: 01 Oct 2013
Handle: RePEc:hhs:rbnkwp:0254
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  1. Mikhail Golosov & Robert E. Lucas, 2003. "Menu Costs and Phillips Curves," NBER Working Papers 10187, National Bureau of Economic Research, Inc.
  2. Carlos Carvalho & Jae Won Lee, 2011. "Sectoral Price Facts in a Sticky-Price Model," Departmental Working Papers 201133, Rutgers University, Department of Economics.
  3. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does It Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 863-904, August.
  4. Peter J. Klenow & Benjamin A. Malin, 2010. "Microeconomic Evidence on Price-Setting," NBER Working Papers 15826, National Bureau of Economic Research, Inc.
  5. Bartosz Mackowiak & Mirko Wiederholt, 2004. "Optimal Sticky Prices under Rational Inattention," SFB 649 Discussion Papers SFB649DP2005-040, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany, revised Jul 2005.
  6. Emi Nakamura & Jón Steinsson, 2012. "Lost in Transit: Product Replacement Bias and Pricing to Market," American Economic Review, American Economic Association, vol. 102(7), pages 3277-3316, December.
  7. Mackowiak, Bartosz Adam & Moench, Emanuel & Wiederholt, Mirko, 2009. "Sectoral Price Data and Models of Price Setting," CEPR Discussion Papers 7339, C.E.P.R. Discussion Papers.
  8. Bartosz Mackowiak & Mirko Wiederholt, 2008. "Business Cycle Dynamics under Rational Inattention," 2008 Meeting Papers 1059, Society for Economic Dynamics.
  9. Patrick J. Kehoe & Virgiliu Midrigan, 2010. "Prices are Sticky After All," NBER Working Papers 16364, National Bureau of Economic Research, Inc.
  10. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
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