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International Price Dispersion in State-Dependent Pricing Models: Theory and Evidence

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  • Virgiliu Midrigan

Abstract

Studies of disaggregated price data document a robust, positive relationship between nominal exchange rate (NER) volatility and the variability of relative prices for cities separated by national borders. This relationship is interpreted as evidence of sticky prices. This paper shows that a state-dependent sticky price model implies a U-shaped rather than monotonic relationship between relative price variability and nominal exchange rate volatility. In relatively calm environments, higher NER volatility lowers relative price variability as firms adjust more frequently. Only when exchange rate volatility is sufficiently large and firms adjust almost instantaneously, does higher nominal exchange rate volatility cause more variable relative prices. We provide empirical support for this result using a novel dataset of homogeneous goods prices collected in Eastern Europe during 1998-2002. Relative price variability is increasing in nominal exchange rate volatility during the years of the Russian financial crisis, but is falling in NER in the calmer years that follow

Suggested Citation

  • Virgiliu Midrigan, 2004. "International Price Dispersion in State-Dependent Pricing Models: Theory and Evidence," 2004 Meeting Papers 206, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:206
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    More about this item

    Keywords

    exchange rates; menu costs; relative price variability;

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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