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State Dependent Adjustment in an Economy with Seasonal Fluctuations

  • Gil Mehrez

    (Georgetown University)

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    Much research on the dynamics of the aggregate economy concerns the adjustment policy of the microeconomic units. This paper investigates the optimal adjustment policy when there are seasonal fluctuations and fixed adjustment costs. The optimal policy in this case can be described in terms of three parameters: the thresholds where adjustment occurs during the high season; the thresholds where adjustment occurs during the low season; and the deviation at the end of each season. Since the optimal level of the control variable (e.g., price, employment, stock of capital) decreases during the low season and increases during the high season, the optimal policy is such that at the end of the high season the control variable is below its optimal level and at the end of the low season the control variable is above its optimal level. As a result, the observed seasonal fluctuations are smaller than the underlying seasonal fluctuations. This damping effect depends on the trend of the process. When the trend is higher in absolute value, the deviation at the beginning of each season decreases and hence the observed seasonal fluctuations increase. For example, if the control variable is the price the firm charges, higher inflation increases the seasonal fluctuations. I test this prediction for the case of price seasonality using price data from Israel for the period 1983-1994. The data provide strong support to the model prediction. Price seasonality increases with the rate of inflation. This is the case especially for goods with market power and significant adjustment costs.

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    Paper provided by EconWPA in its series Macroeconomics with number 9609006.

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    Length: 23 pages
    Date of creation: 25 Sep 1996
    Date of revision:
    Handle: RePEc:wpa:wuwpma:9609006
    Note: Type of Document - WordPerfect; prepared on IBM PC ; to print on HP; pages: 23 ; figures: included .
    Contact details of provider: Web page: http://128.118.178.162

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    1. Parks, Richard W, 1978. "Inflation and Relative Price Variability," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 79-95, February.
    2. Thomas J. Sargent, 1978. "Estimation of dynamic labor demand schedules under rational expectations," Staff Report 27, Federal Reserve Bank of Minneapolis.
    3. Akerlof, George A & Yellen, Janet L, 1985. "A Near-rational Model of the Business Cycle, with Wage and Price Intertia," The Quarterly Journal of Economics, MIT Press, vol. 100(5), pages 823-38, Supp..
    4. Caplin, Andrew S & Spulber, Daniel F, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 703-25, November.
    5. Danziger, Leif, 1988. "Costs of Price Adjustment and the Welfare Economics of Inflation and Disinflation," American Economic Review, American Economic Association, vol. 78(4), pages 633-46, September.
    6. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 381-442.
    7. Caballero, Ricardo J, 1992. "A Fallacy of Composition," American Economic Review, American Economic Association, vol. 82(5), pages 1279-92, December.
    8. Taylor, John B., 1981. "On the relation between the variability of inflation and the average inflation rate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 57-85, January.
    9. Caplin, A. & Leahy, J., 1989. "State-Dependent Pricing And The Dynamics Of Money And Output," Discussion Papers 1989_32, Columbia University, Department of Economics.
    10. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
    11. J. Joseph Beaulieu & Jeffrey K. MacKie-Mason & Jeffrey A. Miron, 1991. "Why Do Countries and Industries with Large Seasonal Cycles Also Have Large Business Cycles?," NBER Working Papers 3635, National Bureau of Economic Research, Inc.
    12. Van Hoomissen, Theresa, 1988. "Price Dispersion and Inflation: Evidence from Israel," Journal of Political Economy, University of Chicago Press, vol. 96(6), pages 1303-14, December.
    13. Bertola, G. & Caballero, R.J., 1990. "Kinked Adjustment Costs And Aggregate Dynamics," Discussion Papers 1990_20, Columbia University, Department of Economics.
    14. Sheshinski, Eytan & Weiss, Yoram, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Wiley Blackwell, vol. 44(2), pages 287-303, June.
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