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Aggregating Phillips Curves

  • FAME,Eric Jondeau, University of Lausanne-HEC
  • Jean Imbs

    (Department of Economics and Econometrics University of Lausanne-HEC, CEPR and FAME)

  • Eric Jondeau

    (University of Lausanne-HEC and FAME)

  • Florian Pelgrin

    ()

    (University of Lausanne-HEC and IEMS)

Since it burst onto the scene of mainstream monetary economics, the New Neo-Classical Phillips Curve has been the focus of two important empirical debates. First, to what extent properly measured marginal costs affect inflation dynamics. Second, to what extent purely forward looking inflation can be reconciled with the data. In this paper, we show heterogeneity in the pricing behavior of firms, matters for both issues. If pricing is heterogeneous, estimations based on GMM techniques are flawed, to an extent that increases with the correlation between aggregate and disaggregate price dynamics. We use sectoral quarterly French data on prices and marginal costs to illustrate this possibility and quantify the magnitude and direction of the implied bias. Two results arise when the estimation accounts for the possibility of heterogeneity. First, marginal costs become substantially more important in affecting inflation dynamics (i.e. heterogeneity induces a negative bias in the response of aggregate inflation to marginal costs). Second, lagged inflation also becomes more important than previously reported using GMM techniques. We provide analytical expressions for the biases which arise when heterogeneity is not taken into account. It helps pinpoint the sources of the differences in results. These are relevant to our data, where they help explain the biases just described, but they also provide a toolkit with which to gauge the magnitude and direction of an aggregation bias in any disaggregated data.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 314.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:314
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