Inflation asymmetry, menu costs and aggregation bias – A further case for state dependent pricing
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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- Etienne Gagnon, 2007.
"Price setting during low and high inflation: evidence from Mexico,"
International Finance Discussion Papers
896, Board of Governors of the Federal Reserve System (U.S.).
- Etienne Gagnon, 2009. "Price Setting During Low and High Inflation: Evidence from Mexico," The Quarterly Journal of Economics, MIT Press, vol. 124(3), pages 1221-1263, August.
- Etienne Gagnon, 2006. "Price Setting during Low and High Inflation: Evidence from Mexico," 2006 Meeting Papers 300, Society for Economic Dynamics.
- Ellingsen, Tore & Friberg, Richard & Hassler, John, 2006. "Menu Costs and Asymmetric Price Adjustment," CEPR Discussion Papers 5749, C.E.P.R. Discussion Papers.
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