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A Flexible View on Prices

  • Nuno Alves
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    This paper argues that the flexible price paradigm is superior to the sticky price paradigm in the context of general equilibrium models. Based on a quarterly data set for six G7 economies, the paper presents two types of evidence showing that prices respond significantly to their underlying fundamentals. First, prices respond contemporaneously and significantly to technology shocks in all countries. Second, the cyclical correlation between prices and unit labor costs is highest contemporaneously and around 0.8 in all cases. This behavior is only consistent with a model where most firms set prices flexibly.

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    Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200406.

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    Date of creation: 2004
    Date of revision:
    Handle: RePEc:ptu:wpaper:w200406
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    1. Roberts, John M & Stockton, David J & Struckmeyer, Charles S, 1994. "Evidence on the Flexibility of Prices," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 142-50, February.
    2. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
    3. Davis, Michael C & Hamilton, James D, 2004. "Why Are Prices Sticky? The Dynamics of Wholesale Gasoline Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(1), pages 17-37, February.
    4. Eden, Benjamin, 1993. "Inflation and Price Adjustment: An Analysis of Micro Data," Working Papers 94-13, University of Iowa, Department of Economics, revised 1994.
    5. Hall, Simon & Walsh, Mark & Yates, Anthony, 2000. "Are UK Companies' Prices Sticky?," Oxford Economic Papers, Oxford University Press, vol. 52(3), pages 425-46, July.
    6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    7. Sbordone, Argia, 1998. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Seminar Papers 653, Stockholm University, Institute for International Economic Studies.
    8. James M. MacDonald & Daniel Aaronson, 2000. "How do retail prices react to minimum wage increases?," Working Paper Series WP-00-20, Federal Reserve Bank of Chicago.
    9. Chris Edmond, 2005. "Sticky Demand or Sticky Prices?," 2005 Meeting Papers 117, Society for Economic Dynamics.
    10. Rudd, Jeremy & Whelan, Karl, 2002. "Does the Labour Share of Income Drive Inflation?," Research Technical Papers 2/RT/02, Central Bank of Ireland.
    11. Robert Dittmar & William Gavin & Finn Kydland, 2002. "Inflation Persistence and Flexible Prices," Computing in Economics and Finance 2002 190, Society for Computational Economics.
    12. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
    13. Dutta, Shantanu & Bergen, Mark & Levy, Daniel, 2002. "Price flexibility in channels of distribution: Evidence from scanner data," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1845-1900, September.
    14. Cecchetti, Stephen G., 1986. "The frequency of price adjustment : A study of the newsstand prices of magazines," Journal of Econometrics, Elsevier, vol. 31(3), pages 255-274, April.
    15. Julio J. Rotemberg, 2002. "Customer Anger at Price Increases, Time Variation in the Frequency of Price Changes and Monetary Policy," NBER Working Papers 9320, National Bureau of Economic Research, Inc.
    16. James M. Nason & Gregor W. Smith, 2008. "Identifying the new Keynesian Phillips curve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 23(5), pages 525-551.
    17. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2003. "The responses of wages and prices to technology shocks," Finance and Economics Discussion Series 2003-65, Board of Governors of the Federal Reserve System (U.S.).
    18. Lach, Saul & Tsiddon, Daniel, 1992. "The Behavior of Prices and Inflation: An Empirical Analysis of Disaggregated Price Data," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 349-89, April.
    19. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2003. "On the Sluggish Response of Prices to Money in an Inventory-Theoretic Model of Money Demand," NBER Working Papers 10016, National Bureau of Economic Research, Inc.
    20. Lawrence J. Christiano & Terry J. Fitzgerald, 2003. "Inflation and monetary policy in the twentieth century," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 22-45.
    21. Andrea Tambalotti, 2004. "Optimal monetary policy and productivity growth," Money Macro and Finance (MMF) Research Group Conference 2003 99, Money Macro and Finance Research Group.
    22. Daniel Aaronson, 2001. "Price Pass-Through And The Minimum Wage," The Review of Economics and Statistics, MIT Press, vol. 83(1), pages 158-169, February.
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