IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Nonlinear Price Adjustment and the Lifetime of a Price Level

  • Magdalena Polan

    ()

    (K.U.Leuven, C.E.S., International Economics)

Registered author(s):

    The objective of this paper is to develop and test empirically a new model of imperfect price adjustment. The new model offers two extensions of classical models. First, it allows for a variable proportion of price-setters adjusting their prices at any given period. Second, the duration of deviation of the price level from the equilibrium level depends on the inflationary environment. In the high-inflation economies, price adjustment is much faster than in the low-inflation economies. Using the existing partial equilibrium models of monopolistic competition [Spence (1976), Dixit and Stiglitz (1977)] and models of imperfect price adjustment [Calvo (1983), Caplin and Spulber (1987)], we construct a new model and show that the inflationary environment (approximated by the average inflation rate) has a positive impact on the number of agents who adjust their prices and negative impact on the duration of the price level. The latter relationship is nonlinear. To test the model we use a sample of data on the price level and the money supply (both M1 and M2) covering the period from 1969 to 1999, consisting of 138 (M1) and 115 countries (M2). After checking for non-stationarity and using the Johansen procedure, we estimate the cointegration relationship between the money supply and the price level. Afterwards, we test the impact of inflationary environment on obtained estimates. We find that the average inflation rate in the analysed period has significant impact on the estimates. First, the cointegrating parameter increases (in absolute value) with the average inflation rate. It means that in high inflation countries the price level follows the money supply more tightly. Second, the error correction parameter increases (also in absolute value) with inflation. This, in turn, means that deviations of the price level from the equilibrium (dictated by the money supply) are corrected much faster in high-inflation economies and that the duration of the price level in these economies is much shorter. We find that this relationship is indeed nonlinear, as predicted by the theoretical model.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.econ.kuleuven.ac.be/ew/academic/intecon/publications/wpie010.pdf
    Download Restriction: no

    Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiƫn, International Economics in its series International Economics Working Papers Series with number wpie010.

    as
    in new window

    Length: 42 pages
    Date of creation: Nov 2002
    Date of revision:
    Handle: RePEc:kul:kulwps:wpie010
    Contact details of provider: Postal: Naamsestraat 69, 3000 Leuven
    Phone: +32-(0)16-32 67 25
    Fax: +32-(0)16-32 67 96
    Web page: http://www.econ.kuleuven.ac.be/ew/academic/intecon
    Email:


    More information through EDIRC

    Order Information: Email:


    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:kul:kulwps:wpie010. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jan Van Hove)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.