Working paper research n° 95 October 2006 Inflation persistence and price-setting behaviour in the euro area : a summary of the Inflation Persistence Network evidence Filippo Altissimo Michael Ehrmann Frank Smets NATIONAL BANK OF BELGIUM WORKING P APERS - RESE ARCH SERIES INFLATION PERSISTENCE AND PRICE-SETTING BEHAVIOUR IN THE EURO AREA: A SUMMARY OF THE IPN EVIDENCE ___________________ Filippo Altissimo (*) Michael Ehrmann (*) Frank Smets (*) This paper was published in the Occasional Paper Series of the European Central Bank: “Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence”, by Filippo Altissimo, Michael Ehrmann and Frank Smets, June 2006. This paper draws heavily on the large number of research papers that have been produced in the context of the Inflation Persistence Network (IPN), a collaborative endeavour of all NCBs of the Eurosystem and the ECB, aimed at conducting an in-depth study of the patterns and determinants of inflation persistence. See the ECB’s website (http://www.ecb.int/home/ html/researcher_ipn.en.html) for a complete list. Moreover, the paper has benefited substantially from comments and input received by members of the IPN. The views expressed are ours and do not necessarily reflect those of the ECB. __________________________________ (*) European Central Bank. E-mail adresses: [email protected]; [email protected]; [email protected]. NBB WORKING PAPER No. 95 - OCTOBER 2006 Editorial Director Jan Smets, Member of the Board of Directors of the National Bank of Belgium Statement of purpose: The purpose of these working papers is to promote the circulation of research results (Research Series) and analytical studies (Documents Series) made within the National Bank of Belgium or presented by external economists in seminars, conferences and conventions organised by the Bank. The aim is therefore to provide a platform for discussion. The opinions expressed are strictly those of the authors and do not necessarily reflect the views of the National Bank of Belgium. The Working Papers are available on the website of the Bank: http://www.nbb.be Individual copies are also available on request to: NATIONAL BANK OF BELGIUM Documentation Service boulevard de Berlaimont 14 BE - 1000 Brussels Imprint: Responsibility according to the Belgian law: Jean Hilgers, Member of the Board of Directors, National Bank of Belgium. Copyright © fotostockdirect - goodshoot gettyimages - digitalvision gettyimages - photodisc National Bank of Belgium Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. ISSN: 1375-680X NBB WORKING PAPER No. 95 - OCTOBER 2006 Editorial On October 12-13, 2006 the National Bank of Belgium hosted a Conference on "Price and Wage Rigidities in an Open Economy". Papers presented at this conference are made available to a broader audience in the NBB Working Paper Series (www.nbb.be). The views expressed in this paper are those of the authors and do not necessarily reflect the views of the National Bank of Belgium or those of European Central Bank. Abstract This paper provides a summary of current knowledge on inflation persistence and price stickiness in the euro area, based on research findings that have been produced in the context of the Inflation Persistence Network. The main findings are: i) Under the current monetary policy regime, the estimated degree of inflation persistence in the euro area is moderate; ii) Retail prices in the euro area are more sticky than in the US; iii) There is significant sectoral heterogeneity in the degree of price stickiness; iv) Price decreases are not uncommon. The paper also investigates some of the policy implications of these findings. JEL-code : Keywords: E31, E42, E52 price-setting; inflation persistence; monetary policy; EMU. NBB WORKING PAPER No. 95 - OCTOBER 2006 TABLE OF CONTENTS Non-Technical Summary ................................................................................................................. 1 Introduction....................................................................................................................................... 3 1 Main findings of the Inflation Persistence Network .............................................................. 3 2 Definition and sources of inflation persistence .................................................................... 5 3 3.1 3.2 3.3 Aggregate inflation dynamics ................................................................................................. 9 Inflation persistence in the euro area: reduced-form estimates ................................................. 9 Evidence from structural models of inflation dynamics............................................................. 12 Heterogeneity across countries and sectors ............................................................................ 15 4 4.1 4.2 4.3 The mechanics of individual price adjustments.................................................................. 17 Patterns of price adjustments ................................................................................................... 18 Price-setting rules: time versus state-dependence................................................................... 22 Available evidence on the reasons for sluggish price dynamics .............................................. 23 5 5.1 5.2 5.3 Inflation persistence and price stickiness: monetary policy implications ....................... 27 Implications for monetary policy ............................................................................................... 28 Some caveats ........................................................................................................................... 31 Other implications for monetary policy ..................................................................................... 34 6 Conclusion .............................................................................................................................. 37 Annex................................................................................................................................................ 28 Bibliography...................................................................................................................................... 42 National Bank of Belgium working paper series............................................................................... 51 NBB WORKING PAPER No. 95 - OCTOBER 2006 ./.4%#(.)#!,35--!29 THESAMPLETOCOVERTHECURRENTPOLICYREGIMEOR BYALLOWINGFORSTATISTICALLYSIGNIFICANTCHANGES INTHEMEANOFINFLATIONMOSTSTUDIESARRIVEAT THE CONCLUSION THAT INFLATION MEASURED AS QUARTERONQUARTERINFLATIONISONLYMODERATELY PERSISTENT -OREOVER THERE IS SOME EVIDENCE THAT THE DEGREE OF INFLATION PERSISTENCE MAY HAVE FALLEN OVER THE LAST DECADE 4HERE IS HOWEVER A CONSIDERABLE DEGREE OF UNCERTAINTY SURROUNDING THOSE ESTIMATES WHICH TYPICALLY ALSODEPENDONTHEINFLATIONINDEXUSED 4HIS PAPER PROVIDES A SUMMARY OF CURRENT KNOWLEDGE ON INFLATION PERSISTENCE AND PRICE STICKINESS IN THE EURO AREA ! 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WAS TO UNDERSTAND THE DYNAMIC PROPERTIES OF INFLATION NOTABLY THE SPEED AND PATTERN OF INFLATION ADJUSTMENT IN RESPONSE TO SHOCKSOFDIFFERENTNATURESANDTHEROLEOFTHE PRICESETTING PROCESS OF FIRMS AND RETAILERS IN GENERATING PERSISTENCE 7HEREAS INFLATION CAN BE MOVED PERSISTENTLY FROM TARGET DUE TO A SEQUENCEOFSHOCKSTHEFOCUSOFTHISPAPERWILL BETOSHEDLIGHTONTHEQUESTIONOFHOWINFLATION BEHAVESINRESPONSETOAGIVENSHOCK4HENOTION OFPERSISTENCEUSEDINTHISPAPERDOESNOTREFER TO SITUATIONS WHERE IN THE ABSENCE OF SHOCKS INFLATION REMAINS PERSISTENTLY AT TARGET BUT INSTEAD EMPHASISES HOW QUICKLY INFLATION RETURNS TO TARGET ONCE IT HAS DEVIATED FROM IT !CCORDINGLY THE DEFINITION OF INFLATION PERSISTENCE USED BY THE )0. REFERS TO THE TENDENCYOFINFLATIONTOCONVERGESLOWLYTOWARDS ITSLONGRUNVALUEFOLLOWINGASHOCKWHICHHAS LEDINFLATIONAWAYFROMITSLONGRUNVALUE IV 0RICEDECREASESARECOMMON 4HEMICROEVIDENCEOFTHE)0.SHOWSTHATPRICE DECREASES ARE COMMON WITH THE NOTABLE EXCEPTIONOFSERVICES/NAVERAGEAROUND OFPRICECHANGESAREPRICEREDUCTIONSWHEREAS INSERVICESTHISNUMBERSTANDSAT,OOKING ATTHEMAGNITUDEOFPRICECHANGESITTURNSOUT THAT PRICE INCREASES AS WELL AS DECREASES ARE SIZEABLE COMPARED TO THE INFLATION RATE 4HE AVERAGECONSUMERPRICEINCREASEISFOUNDTOBE 4HEPRACTICALRELEVANCEOFTHISQUESTIONCANBE IN THE ORDER OF AND THE AVERAGE PRICE EASILYSEENBYLOOKINGATTHEMAINFACTORSTHAT DECREASESLIGHTLYLARGERAT HAVE AFFECTED INFLATION IN THE EURO AREA IN THE YEARSSINCETHEINTRODUCTIONOFTHEEURO6ARIOUS 4HE FINDING THAT OVERALL PRICE FALLS ARE VERY SHOCKS RELATED TO STRONG EXCHANGE RATE COMMON HAS IMPORTANT IMPLICATIONS FOR THE MOVEMENTS ANIMAL DISEASES ADVERSE WEATHER OPTIMALINFLATIONOBJECTIVE)THASBEENARGUED CONDITIONSTHECASHCHANGEOVERFISCALMEASURES THATDOWNWARDNOMINALPRICERIGIDITIESTHATARE ANDOILPRICESHOCKSHAVEMOVEDINFLATIONAWAY NOT MATCHED BY SIMILAR UPWARD RIGIDITIES MAY FROM THE DEFINITION OF PRICE STABILITY !T THE JUSTIFY A HIGHER INFLATION OBJECTIVE IN ORDER TO SAMETIMEINFLATIONHASREMAINEDSYSTEMATICALLY FACILITATE RELATIVE PRICE ADJUSTMENTS 4HE )0. FINDINGSDONOTSUGGESTTHATTHISISANIMPORTANT 3EE!NGELONIETAL 5 ABOVE FOR A PROLONGED PERIOD DESPITE RELATIVELY WEAK ECONOMIC PERFORMANCE 4O UNDERSTAND THIS PATTERN OF INFLATION IT IS IMPORTANTTOASCERTAINWHETHERTHISPERSISTENCE HASBEENDUETOIASEQUENCEOFADVERSESHOCKS II THE INERTIAL RESPONSE OF INFLATION FOLLOWING EACHOFTHOSESHOCKSORIIIOTHERREASONSSUCH ASANOVERESTIMATIONOFTHEDEGREEOFSLACKIN THEECONOMYANINSUFFICIENTRESPONSEOFFIRMS COST FACTORS SUCH AS WAGES TO THE WEAK ECONOMICPERFORMANCEORALARGERTHANEXPECTED SACRIFICE RATIO &URTHERMORE LOOKING AHEAD IT ISIMPORTANTFORTHECONDUCTOFMONETARYPOLICY TOBEABLETOASSESSEXANTEHOWLONGINFLATION WILLBEMOVEDAWAYFROMTHEDEFINITIONOFPRICE STABILITYINTHEAFTERMATHOFSUCHSHOCKS 6ARIOUSFACTORSMAYLIEBEHINDASLOWADJUSTMENT OFINFLATION4HEDISCUSSIONINTHISSECTIONWILL HIGHLIGHTTHEMOSTIMPORTANTONESDISTINGUISHING BETWEEN I PERSISTENCE THAT IS INHERITED FROM PERSISTENT FLUCTUATIONS IN THE DETERMINANTS OF INFLATION SUCH AS MARGINAL COSTS OR THE OUTPUT GAP hEXTRINSIC PERSISTENCEv II THE DEPENDENCE OF INFLATION ON ITS OWN PAST hINTRINSIC PERSISTENCEv AND III PERSISTENCE DUE TO THE FORMATION OF INFLATION EXPECTATIONS hEXPECTATIONSBASED PERSISTENCEv %ACH OF THESETHREESOURCESOFINFLATIONPERSISTENCECAN BE ASSOCIATED WITH ONE OF THE THREE TERMS IN A TRADITIONAL.EW+EYNESIAN0HILLIPSCURVEWHICH RELATES CURRENT INFLATION TO ITS OWN LAG THE EXPECTATION OF FUTURE INFLATION THE OUTPUT GAP ANDACOSTPUSHSHOCK º Tº Tn% Tº T´Y TU T RELATIONWHICHLINKSTHECURRENTOUTPUTGAPTO ITS OWN LAGGED AND FUTURE EXPECTED VALUE THE REAL INTEREST RATE AND A DEMAND SHOCK AND AN EQUATIONCAPTURINGTHEBEHAVIOUROFTHEPOLICY MAKERWHOCANSETPOLICYEITHERACCORDINGTOA SIMPLERULESUCHASTHEPROMINENT4AYLORRULE OR IN AN hOPTIMALv FASHION DEPENDING ON THE STRUCTUREOFTHEECONOMY$ESPITETHESIMPLICITY OF THE DESCRIBED MODEL IT IS RICH ENOUGH TO PROVIDE THE PROPER INTUITION ON THE MAIN LINK BETWEEN INFLATION PERSISTENCE AGENTS EXPECTATIONSANDPOLICYDESIGN %XTRINSICPERSISTENCE &IRMS GENERALLY DO NOT RESET PRICES ON THE PRODUCTSTHEYSELLEVERYDAY4HISCOULDBEFOR MULTIPLEREASONS&ORINSTANCEITCOULDSIMPLY BE TOO COSTLY TO CALCULATE A NEW PRICE FOR A FIRMSENTIRERANGEOFPRODUCTSEVERYDAY4HIS IMPLIES THAT OVER TIME PRICES COULD BE OUT OF LINE WITH THE CURRENT ECONOMIC SITUATION EG PRICESOFINPUTSDEMANDSITUATION3INCEFIRMS REALISE THAT THEIR PRICES WILL BE FIXED FOR A CERTAINPERIODTHEYWILLLIKELYINCORPORATETHE EXPECTED FUTURE EVOLUTION OF THE ECONOMIC VARIABLESTHATARERELEVANTFORTHEPRICESETTING DECISIONFORINSTANCETHEFUTUREPRICESOFTHEIR 3UCHAMODELOFINFLATIONDYNAMICSCANBEDERIVEDFROMMICRO FOUNDATIONS UNDER THE ASSUMPTION THAT PRICESETTERS OPERATE IN MONOPOLISTICALLY COMPETITIVE GOODS MARKETS WITH SOCALLED #ALVOSTYLECONTRACTSWHEREBYTHEREISAFIXEDPROBABILITYTHAT A FIRM RESETS ITS PRICE IN EACH PERIOD 4HIS ASSUMPTION WILL HOWEVERLEADTOAPURELYFORWARDLOOKINGMODEL4HEADDITION OF A LAGGED INFLATION TERM CAN BE JUSTIFIED FOR EXAMPLE BY ASSUMINGPARTIALINDEXATIONOFPRICESOFTHOSEPRICESETTERSTHAT CANNOT REOPTIMISE IN A GIVEN PERIOD 4HE DEGREE OF PRICE STICKINESSWILLAFFECTTHERESPONSEOFINFLATIONTOOUTPUTNAS WELLASTHEVARIANCEOFCOSTPUSHSHOCKSV UTHESTICKIERPRICES ARETHESMALLERNANDTHESMALLERV U 4HE SIMULATIONS IN THIS SECTION ARE BASED ON THE FOLLOWING MODEL !LTHOUGH THESE SOURCES OF PERSISTENCE WILL BE DISCUSSED SEPARATELY IN THE REMAINDER OF THIS SECTION IT IS IMPORTANT TO EMPHASISE THAT THEY MAYBEDIFFICULTTODISTINGUISHINTHEORYASWELL AS EMPIRICALLY SINCE THEY INTERACT WITH EACH OTHER AND THEIR RELATIVE IMPORTANCE WILL ALSO VERY MUCH DEPEND ON THE MONETARY POLICY REGIMEANDTHEPOLICYREACTIONFUNCTION 4OILLUSTRATETHISWEWILLMAKEUSEOFASMALL STYLISED MODEL OF THE ECONOMY WHICH CONSISTS OF A 0HILLIPS CURVE AS DESCRIBED ABOVE AN )3 6 0HILLIPSCURVE )3CURVE 4AYLORRULE WHERE º IS INFLATION Y IS THE OUTPUT GAP % DENOTES THE EXPECTATIONSOPERATORUISACOSTPUSHSHOCK¯ADEMANDSHOCK ANDRISTHEPOLICYRATE4HEPARAMETERSARECALIBRATEDFOLLOWING 3METSJNGVVHV U D SD YO 4HESIMULATIONSUNDERLEARNINGASSUME THAT THE PRIVATE SECTOR DOES NOT KNOW THE PARAMETERS OF THE MODEL)NSTEADAGENTSHAVETOLEARNTHEPARAMETERVALUES4HIS ISDONETHROUGHSOCALLEDCONSTANTGAINLEARNINGWHEREBYMORE DISTANTOBSERVATIONSAREALLOTTEDSMALLERWEIGHTS RAW MATERIALS /N THE OTHER HAND PAST DEVELOPMENTS WILL AFFECT PRICESETTING IF THESE AREPERSISTENTEGWAGESETTLEMENTS3OBOTH THEPASTANDTHEEXPECTEDFUTUREEVOLUTIONOFTHE ECONOMICSITUATIONWILLHAVEANEFFECTONPRICE SETTING DECISIONS 3INCE NOT ALL FIRMS IN THE ECONOMY WILL REACT SIMULTANEOUSLY TO CHANGES INTHEECONOMICENVIRONMENTTHISTYPEOFPRICE SETTING BEHAVIOUR CAN LEAD TO PERSISTENCE IN INFLATIONESPECIALLYIFTHEECONOMICENVIRONMENT EGINPUTPRICESSHOWSPERSISTENTCHANGES)N SUCHCASESINFLATIONINHERITSTHEPERSISTENCEOF ITS PROXIMATE DETERMINANTS SUCH AS THE REAL MARGINALCOSTORTHEOUTPUTGAP4HISISWHATIS CALLEDhEXTRINSICINFLATIONPERSISTENCEv &IGURE4HERESPONSEOFINFLATIONTOA COSTPUSHSHOCKFORDIFFERENTVALUESOFPRICE STICKINESS .OTE 4HE DIFFERENT IMPULSE RESPONSE FUNCTIONS ARE DERIVED USINGTHETHREEREPORTEDVALUESOFNWHICHITSELFDEPENDSONTHE DEGREE TO WHICH PRICES ARE STICKY IN THE ECONOMY IN THE .EW +EYNESIANMODELDESCRIBEDINFOOTNOTE(IGHERVALUESOFNARE RELATED WITH LOWER PRICE STICKINESS .UMBERS ON THE XAXIS DENOTEQUARTERS 4HE MORE RIGID PRICES ARE THE LESS RESPONSIVE INFLATION BECOMES TO CHANGES IN ITS PROXIMATE DETERMINANTS SUCH AS THE OUTPUT GAP !CCORDINGLY MORE PRICE STICKINESS IMPLIES LOWERVALUESOFNINTHE.EW+EYNESIANMODEL !T THE SAME TIME HOWEVER IT IS IMPORTANT TO NOTETHATTHISPARAMETERISALSOAFFECTEDBYTHE DEGREE OF REAL RIGIDITIES FOR EXAMPLE THE SENSITIVITY OF REAL WAGES TO CHANGES IN THE DEGREEOFECONOMICSLACK&INALLYTHERESPONSE OF INFLATION TO A SHOCK WILL OBVIOUSLY ALSO DEPEND ON THE INERTIA OF THE OUTPUT GAP ITSELF &IGURE ILLUSTRATES THE IMPORTANCE OF PRICE STICKINESSBYPLOTTINGTHERESPONSEOFINFLATION TOACOSTPUSHSHOCKWHICHINITIALLYINCREASES INFLATIONBYFORTHREEDIFFERENTVALUESOFN PROXYING FOR DIFFERENT DEGREES OF PRICE STICKINESS4HEEXPERIMENTSHOWSTHERESPONSE FORAEUROAREABENCHMARKMODELINTHEMIDDLE LINEANDTHENARBITRARILYPICKSTWOOTHERVALUES FOR N ONE HIGHER AND ONE LOWER 4HE FIGURE SHOWS THAT THE RESPONSE OF INFLATION BECOMES FLATTER WITH MORE STICKY PRICES IE IT TAKES LONGERFORINFLATIONTORETURNTOTHEVALUEITHAD BEFORE THE SHOCK OCCURRED )T IS IMPORTANT TO NOTETHATTHISPOSITIVERELATIONSHIPBETWEENTHE DEGREE OF INFLATION PERSISTENCE AND THE DEGREE OFPRICESTICKINESSALSODEPENDSONTHEDEGREE TOWHICHINFLATIONDEPENDSONITSOWNPASTAND ONTHEBEHAVIOUROFTHEPOLICYMAKERSASWILL BESHOWNBELOW )NTRINSICPERSISTENCE %VENINTHEPRESENCEOFNOMINALRIGIDITIESITIS NOT CLEAR WHY INFLATION SHOULD DEPEND ON ITS OWNPASTONCEDEVELOPMENTSINTHEDETERMINANTS OF INFLATION HAVE BEEN ACCOUNTED FOR )F FIRMS CANCHANGEPRICESLESSOFTENTHESENSITIVITYOF INFLATION TO CHANGES IN CURRENT AND FUTURE MARGINAL COSTS WILL BE REDUCED BUT IT CANNOT EXPLAINWHYINFLATIONSHOULDDEPENDONITSOWN HISTORY 3UCH DEPENDENCE CAN BE GENERATED IN THEORETICAL MODELS THROUGH THE ASSUMPTION OF INDEXATION OR RULEOFTHUMB BEHAVIOUR ON THE PART OF THE PRICESETTERS !N INCREASE IN THE FRACTIONOFFIRMSTHATSETPRICESINABACKWARD LOOKINGFASHIONCETERISPARIBUSRAISESINFLATION PERSISTENCE 3IMILARLY AN INCREASE IN THE IMPORTANCE OF BACKWARDLOOKING INDEXATION 4HISEXPERIMENTWASCONDUCTEDKEEPINGCONSTANTTHEINERTIAIN THE DRIVERS OF INFLATION AND THE DEPENDENCE OF INFLATION ON ITS OWNPAST.OTEALSOTHATMOREPRICESTICKINESSWILLREDUCETHE VARIANCEOFTHECOSTPUSHSHOCKU TWHICHISNOTCONSIDEREDIN THE SIMULATIONS PERFORMED HERE 7HILE IN THIS SECTION SIMULATIONS WILL ONLY BE PERFORMED FOR COSTPUSH SHOCKS THE EMPIRICAL EVIDENCE WILL NOT GENERALLY DISTINGUISH BETWEEN THE SOURCESOFSHOCKS )N THE STANDARD MICROFOUNDED MACRO MODELS OF INFLATION DETERMINATION#ALVO4AYLOROR2OTEMBERG THERE IS GENERALLY NO INDEPENDENT ROLE FOR LAGGED INFLATION! STANDARD 4AYLORCONTRACTING MODEL EVEN IMPLIES THAT INFLATION WILLDEPENDNEGATIVELYONPASTINFLATIONONCETHEIMPACTOFTHE CURRENTANDEXPECTEDEVOLUTIONOFITSDETERMINANTSISTAKENINTO ACCOUNT7HELAN 7 &IGURE4HERESPONSEOFINFLATIONTOA COSTPUSHSHOCKWITHANDWITHOUTLEARNING &IGURE4HERESPONSEOFINFLATIONTOA COSTPUSHSHOCKFORDIFFERENTVALUESOF hBACKWARDLOOKINGNESSv .OTE 4HE DIFFERENT IMPULSE RESPONSE FUNCTIONS ARE DERIVED USINGTHETHREEREPORTEDVALUESOFJINTHE.EW+EYNESIANMODEL DESCRIBED IN FOOTNOTE .UMBERS ON THE XAXIS DENOTE QUARTERS .OTE4HEDIFFERENTIMPULSERESPONSEFUNCTIONSFROMAMODELAS DESCRIBED IN FOOTNOTE RATIONAL EXPECTATIONS CASE AND A MODEL WHERE THE PRIVATE SECTOR NEEDS TO LEARN ABOUT THE PARAMETERSINTHEMODEL4HISISDONETHROUGHSOCALLEDCONSTANT GAINLEARNING.UMBERSONTHEXAXISDENOTEQUARTERS WILL GENERALLY ALSO INCREASE THE DEGREE OF INFLATIONPERSISTENCE)NTHECONTEXTOFTHE.EW +EYNESIAN0HILLIPSCURVEDISCUSSEDABOVETHIS IMPLIES THAT THE PARAMETER ON LAGGED INFLATION BECOMESMOREIMPORTANT&IGUREILLUSTRATES THIS EFFECT ON THE PERSISTENCE OF INFLATION IN RESPONSETOACOSTPUSHSHOCKINANALOGYTOTHE SIMULATIONSPERFORMEDIN&IGURE4HEDEGREE TOWHICHLARGERCOEFFICIENTSONLAGGEDINFLATION GENERATE LARGER INFLATION PERSISTENCE IS IMMEDIATELYAPPARENTFROMTHISFIGURE MAYUSESIMPLEREDUCEDFORMAUTOREGRESSIONS TO FORECAST INFLATION 4HIS TYPE OF LEARNING MAKES THE PERCEIVED AND ACTUAL DEGREE OF INFLATION PERSISTENCE TIMEVARYING AND A FUNCTION OF THE HISTORY OF SHOCKS &IGURE ILLUSTRATES THAT THIS TYPE OF LEARNING BEHAVIOUR WILL ALSO GENERALLY INCREASE INFLATION PERSISTENCE %XPECTATIONSBASEDPERSISTENCE -OST THEORIES OF INFLATION DYNAMICS ACCORD A SIGNIFICANTROLETOINFLATIONEXPECTATIONSINTHE DETERMINATIONOFINFLATION(OWEVERUNDERTHE ASSUMPTION OF RATIONAL EXPECTATIONS INFLATION EXPECTATIONSBYTHEMSELVESWILLNOTCONTRIBUTE TOTHEPERSISTENCEOFTHEINFLATIONPROCESS4HIS RESULT CHANGES HOWEVER ONCE RELATIVELY SMALL DEVIATIONS FROM THE ASSUMPTION OF PERFECT INFORMATION ARE ALLOWED FOR &OR EXAMPLE IMPERFECT INFORMATION ABOUT THE NATURE OF SHOCKS EG WHETHER THEY ARE TEMPORARY OR PERMANENTTHATAREAFFECTINGTHEECONOMYMAY LEAD TO MORE PERSISTENT AND GRADUAL RESPONSES OFINFLATIONTOSHOCKSASECONOMICAGENTSNEED TOLEARNABOUTTHEUNDERLYINGCHARACTERISTICSOF A SHOCK 3IMILARLY WHEN PRICESETTERS DO NOT KNOWTHEPRECISESTRUCTUREOFTHEECONOMYTHEY 8 4HEROLEOFMONETARYPOLICY %ACHOFTHEFACTORSDISCUSSEDABOVEWILLPLAYAN IMPORTANTROLEINDETERMININGTHEOVERALLDEGREE OF INFLATION PERSISTENCE (OWEVER IT IS WORTH EMPHASISING AGAIN THAT THE MONETARY POLICY REACTION FUNCTION WILL ALSO PLAY A CRUCIAL ROLE 4OILLUSTRATETHIS&IGURESHOWSFORINSTANCE HOWTHEDEGREEOFINTERESTRATESMOOTHINGBYTHE CENTRAL BANK WILL AFFECT THE SPEED WITH WHICH INFLATIONREVERTSBACKTOITSLONGRUNLEVEL7ITH MORESMOOTHINGINTERESTRATESWILLREACTMORE SLOWLYBUTWILLALSOBEHIGHERFORAPROLONGED PERIODOFTIME)NRESPONSETOTHELATTERINFLATION &OREXAMPLE%HRMANNAND3METSSHOWTHATTHEEFFECTS OFACOSTPUSHSHOCKBECOMEMOREPERSISTENTWHENTHEPRIVATE SECTORCANNOTDISTINGUISHBETWEENTEMPORARYCOSTPUSHSHOCKS ANDPERMANENTSHOCKSTOPOTENTIALOUTPUT3IMILARLY%RCEGAND ,EVIN EXPLAIN THE PERSISTENT EFFECTS OF THE 6OLKER DISINFLATION BY THE PRIVATE SECTORS LEARNING ABOUT WHETHER THE MONETARY POLICY INDUCED FALL IN INFLATION IS PERMANENT OR TEMPORARY 'ASPAR3METSAND6ESTIN &IGURE$ECAYOFINFLATIONFOLLOWINGA SHOCKFORDIFFERENTVALUESOFCÁ &IGURE4HERESPONSEOFINFLATIONTOA COSTPUSHSHOCKFORDIFFERENTVALUESOF INTERESTRATESMOOTHING .OTE.UMBERSONTHEXAXISREFERTOQUARTERS .OTE 4HE DIFFERENT IMPULSE RESPONSE FUNCTIONS ARE DERIVED USING THE THREE REPORTED VALUES OF O IN THE .EW +EYNESIAN MODEL DESCRIBED IN FOOTNOTE .UMBERS ON THE XAXIS DENOTE QUARTERS EXPECTATIONS WILL BE REDUCED MORE QUICKLY ORDER TO GIVE AN IDEA OF HOW FAST INFLATION WHICH LEADS TO A QUICKER RETURN OF INFLATION TO RETURNSBACKTOITSMEANFOLLOWINGADISTURBANCE IT MEASURES THE DEPENDENCE OF INFLATION ON ITS ITSEARLIERLEVEL PASTVALUES3PECIFICALLYITCALCULATESTHESUM OFCOEFFICIENTSDENOTEDBY»INAREGRESSIONOF INFLATION ON ITS PAST VALUES 4O GIVE AN !''2%'!4%).&,!4)/.$9.!-)#3 ILLUSTRATION OF THE PROPERTIES OF THIS MEASURE (AVINGGONETHROUGHTHEVARIOUSDETERMINANTS &IGURE SHOWS HOW INFLATION BEHAVES IN OF INFLATION PERSISTENCE IN THIS 3ECTION WE RESPONSE TO A SHOCK THAT INITIALLY INCREASES DOCUMENTTHEEVIDENCEFORTHEEUROAREABASED ON MACRO AND SECTORAL DATA 3ECTION FIRST 4HISISCOMPARABLETOASITUATIONWHERETHECENTRALBANKCONDUCTS OPTIMALPOLICYUNDERCOMMITMENT)NSUCHASITUATIONINTEREST PRESENTS THE REDUCEDFORM EVIDENCE ON MACRO RATES WILL BE HISTORYDEPENDENT WHICH RESEMBLES THE INTEREST INFLATION PERSISTENCE )N LIGHT OF THE WORKING RATE SMOOTHING IN THE CURRENT SETUP IN THAT INTEREST RATES WILL DEFINITION OF INFLATION PERSISTENCE MENTIONED RESPONDLESSINITIALLYBUTREMAINHIGHERFORALONGERPERIODOF TIME THAN OTHERWISE4HE MAIN EFFECT OF THIS POLICY IS TO STEER ABOVEANIMPORTANTQUESTIONISHOWTOTAKEINTO INFLATIONEXPECTATIONS!SIN&IGURESUCHAPOLICYWILLTEND ACCOUNT SHIFTS IN THE MEDIUMTERM INFLATION TO GENERATE hUNDERSHOOTINGv OF INFLATION AFTER A WHILE IE INFLATIONWILLBELOWERTHANITSINITIALLEVELFORSOMETIME OBJECTIVE OF THE CENTRAL BANK 3ECTION )N MORE DETAIL THE SUM OF AUTOREGRESSIVE COEFFICIENTS SUMMARISES THE AVAILABLE EVIDENCE ON THE + IN UNIVARIATE TIMESERIES MODELS P T M £ J A JP T J E T IS + ESTIMATIONOFSTRUCTURALINFLATIONEQUATIONSSUCH GIVENAS R £ J A J /THERMEASURESTHATCANBEOBTAINEDIN UNIVARIATEMODELSINCLUDETHELARGESTAUTOREGRESSIVEROOTORTHE AS EQUATION ABOVE &INALLY 3ECTION HALFLIFEOFINNOVATIONSEG#OGLEYAND3ARGENT0IVETTA DISCUSSES THE EVIDENCE BASED ON SECTORAL DATA AND 2EIS ,EVIN AND 0IGER )N ADDITION MEASURES ANDTHEAGGREGATIONEFFECT BASEDONFREQUENCYDOMAINMETHODSSUCHASTHESPECTRALDENSITY AT FREQUENCY ZERO EG "ENATI HAVE BEEN USED6ARIOUS AUTHORSHAVEALSOUSEDMULTIVARIATEMETHODOLOGIESTOCALCULATE THERESPONSEOFINFLATIONTOVARIOUSDISTURBANCESEG"ATINIAND .ELSON "ATINI !NOTHER ALTERNATIVE THAT HAS ALSO BEENEMPLOYEDINSOMESTUDIESMENTIONEDINTHISPAPEREXPLOITS THEIDEATHATIFINFLATIONISNOTVERYPERSISTENTITSHOULDCROSSITS MEAN RELATIVELY FREQUENTLY AND MEASURES THE NUMBER OF THESE INCIDENTSFORTHEDERIVATIONOFTHISESTIMATORANDADISCUSSION OF THE ADVANTAGES AND DISADVANTAGES OF SEVERAL MEASURES OF PERSISTENCE SEE 2OBALO -ARQUES AND $IAS AND 2OBALO -ARQUES ).&,!4)/.0%23)34%.#%).4(%%52/ !2%!2%$5#%$&/2-%34)-!4%3 4HEOVERALLDEGREEOFINFLATIONPERSISTENCECAN BE MEASURED IN A LARGE NUMBER OF WAYS 4HE RESULTS REPORTED HERE ARE BASED ON THE METHOD THATISMOSTFREQUENTLYUSEDINTHELITERATURE)N 9 INFLATIONBYASSUMINGTHATINFLATIONDEPENDS MERELYONITSFIRSTLAG4HESPEEDWITHWHICH INFLATIONRETURNSBACKTOWARDSTHELEVELBEFORE THESHOCKDEPENDSSTRONGLYON»4HEHIGHER» THE LONGER IT TAKES INFLATION TO RETURN 4HE HORIZONTAL LINE IS DRAWN AT A VALUE OF !CCORDINGLY INFLATION CROSSES THIS LINE AT THE POINTINTIMEWHENHALFOFTHEINITIALSHOCKHAS BEEN ABSORBED 4HE FIGURE SHOWS CLEARLY THAT THE SPEED OF THE ABSORPTION PROCESS DECREASES MORETHANPROPORTIONALLYWITHINCREASINGLEVELS OF»&ORVALUESOF»BELOWHALFOFTHEINITIAL SHOCKTOINFLATIONHASBEENREABSORBEDALREADY WITHIN THREE QUARTERS !CCORDINGLY SUCH A PROCESSCANBEEASILYBROUGHTBACKTOITSTARGET LEVELINTHEMEDIUMTERM)TISIMPORTANTTONOTE THATTHESAMEPROCESSWILLAPPEARMOREPERSISTENT IFANALYSEDINYEARONYEARCHANGESASOPPOSED TO THE QUARTERONQUARTER CHANGES IN THIS FIGURE INFLATION4HELOWERPANELOF4ABLEREPORTS ANALTERNATIVESETOFESTIMATESFORTHEEUROAREA OFTENTAKENFROMTHESAMESTUDIES4HEMAIN DIFFERENCEBETWEENTHETWOPANELSLIESEITHERIN THE LENGTH OF THE TIME SAMPLE USED WHICH IS MUCHSHORTERINTHELOWERPANELORINWHETHER THE ANALYSIS ALLOWS FOR STATISTICALLY SIGNIFICANT BREAKS IN THE MEAN OF INFLATION OR SOME OTHER SORTOFTIMEVARYINGMEAN/VERALLMOSTSTUDIES FIND STATISTICAL EVIDENCE IN FAVOUR OF SHIFTS IN THE MEAN OF INFLATION -OREOVER ONCE SUCH SHIFTS ARE ALLOWED FOR THE »ESTIMATES ARE CONSIDERABLY LOWER THAN THOSE REPORTED IN THE UPPERPANELANDGENERALLYSTATISTICALLYDIFFERENT FROMONEINDICATINGTHATINFLATIONISNOTHIGHLY PERSISTENT (OWEVER IT IS IMPORTANT TO STRESS THATGENERALLYTHESEESTIMATESARESURROUNDED BYALARGEMARGINOFUNCERTAINTYSUCHTHATITIS DIFFICULTTOPINDOWNTHEDEGREEOFPERSISTENCE WITH PRECISION !NOTHER LAYER OF UNCERTAINTY ARISES BECAUSE DIFFERENT STUDIES ARRIVE AT DIFFERENTNUMBERSDUETODIVERSESAMPLEPERIODS OR METHODOLOGICAL APPROACHES AS HIGHLIGHTED IN4ABLE &INALLY THERE IS ALSO UNCERTAINTY ABOUTTHEAPPROPRIATEMEASURETOBEAPPLIEDFOR SUCHTESTS 4ABLE REPORTS ESTIMATES OF » FROM VARIOUS STUDIESONINFLATIONPERSISTENCEINTHEEUROAREA 4HEUPPERPANELREPORTSRESULTSTHATHAVEBEEN OBTAINEDFORRELATIVELYLONGTIMESPANSWITHOUT ALLOWING FOR POTENTIAL CHANGES IN MONETARY POLICY REGIMES AND THE MEAN OF INFLATION )T TURNSOUTTHATINTHISCASEMOSTESTIMATESARENOT SIGNIFICANTLY DIFFERENT FROM ONE 4HIS IMPLIES THATINFLATIONBEHAVESINANEXTREMELYPERSISTENT FASHION IF IT WERE EQUAL TO ONE A DISTURBANCE THAT MOVES INFLATION EVEN IF TEMPORARY ITSELF WOULDHAVEAPERMANENTEFFECTONTHELEVELOF 'IVEN THE WORKING DEFINITION OF INFLATION PERSISTENCE AS THE TENDENCY OF INFLATION TO CONVERGE SLOWLY OR SLUGGISHLY TOWARDS THE LONGRUNVALUEIMPLIEDBYTHEMONETARYPOLICY REGIMEINPLACEITISCRUCIALFROMANECONOMIC POINTOFVIEWTOALLOWFORPERSISTENTCHANGESIN 4ABLE%STIMATEDINFLATIONPERSISTENCEFORTHEEUROAREA 3OURCE U 3AMPLE )NFLATIONSERIESANALYSED )) ))))) ))))) ))6 ))6 #0) ()#0 '$0DEmATOR#0)()#0ANDCOREINmATION '$0DEmATORAND()#0 #0) 3IMPLEESTIMATESOVERLONGTIMESAMPLES !LTISSIMO-OJON:AFFARONI "ATINI 'ADZINSKI/RLANDI /2EILLY7HELAN 2OBALO-ARQUES %STIMATESWITHTIMEVARIATIONSINTHEMEANOFINmATIONOROVERSHORTTIMESAMPLES $OSSCHE%VERAERT 'ADZINSKI/RLANDI ,àNNEMANN-ATHÊ /2EILLY7HELAN 2OBALO-ARQUES )))6 )))) ))6 ))6 .OTE0ARAMETERSINBOLDINDICATETHATITISPOSSIBLETOREJECTSTATISTICALLYTHAT U 10 '$0DEmATOR '$0DEmATOR#0)()#0ANDCOREINmATION ()#0 ()#0 #0) EVIDENCETHATTHEMEANOFINFLATIONHASCHANGED INAHIGHLYPERSISTENTFASHION!TTHESAMETIME THEESTIMATEDBREAKPOINTIN)ISSUGGESTIVE AS IT COINCIDES WITH A CHANGING ATTITUDE OF POLICYMAKERS TOWARDS THE %2- n THE START OF WHAT HAS OFTEN BEEN CALLED THE hHARD %2-v %STIMATING INFLATION PERSISTENCE FOR THE TWO SUBSAMPLESYIELDSFORTHETIMEUNTIL ANDASREPORTEDINTHELASTROWOF4ABLE FORTHELATERSAMPLE &IGURE#ONSUMERPRICEINFLATIONINTHE EUROAREA)))6 3ECOND IF CHANGES IN MONETARY POLICY ARE THE DRIVINGFORCEONESHOULDEXPECTTOSEEBREAKS OCCURRINGINASIMILARFASHIONFORMOSTSECTORAL INFLATIONSERIES4HISALLOWSFORANATURALTESTFOR THE ROLE OF MONETARY POLICY IN BRINGING ABOUT THEOBSERVEDCHANGESINTHEMEANOFINFLATION ,OOKINGATLONGTIMESAMPLESFOR"ELGIUMAND &RANCEITISAPPARENTTHATBREAKSOCCURATSIMILAR DATES FOR MOST SECTORS 4HE TIMING OF THESE BREAKSSUGGESTSTHATTHEYAREINDEEDDRIVENBY MONETARY POLICY4HE BREAK DATES DETECTED FOR OVERALL INFLATION AS WELL AS FOR A SECTORAL SUB INDICESCLUSTERAROUNDAFEWMONTHSINTHEMID S WERE CLOSELY LINKED TO THE TIMES WHEN MONETARY POLICY TIGHTENED CONSIDERABLY IN &RANCE SHORTLY AFTER WAGE AND PRICE FREEZES IN AND IN "ELGIUM AFTER WAGE MODERATIONS AND THE DEVALUATION OF THE "ELGIAN FRANC IN 3OURCE2OBALO-ARQUES THEMEANOFINFLATIONTHATAREDRIVENBYSHIFTSIN THE INFLATION OBJECTIVE WHEN MEASURING THE DEGREEOFPERSISTENCE(OWEVERFROMAPURELY STATISTICAL PERSPECTIVE IT IS NOT EASY TO DISTINGUISHBETWEENAHIGHLYPERSISTENTINFLATION PROCESSANDALESSPERSISTENTONEWITHOCCASIONAL SHIFTSINTHEMEAN&AILURETOACCOUNTFORBREAKS IN THE MEAN COULD YIELD SPURIOUSLY HIGH ESTIMATESOFTHEDEGREEOFPERSISTENCE /NTHE OTHER HAND HIGHLY PERSISTENT PROCESSES CAN EASILY LEAD A TIME SERIES AWAY FROM ITS OVERALL MEAN FOR CONSIDERABLE AMOUNTS OF TIME SUCH THATTHEEXISTENCEOFTRUEBREAKSISDIFFICULTTO DETECT -OREOVERTHEREMAYBEOTHERREASONS FOR A CHANGE IN THE MEAN OF INFLATION SUCH AS CHANGES IN THE MEASUREMENT OF INFLATION OR CHANGESINSECTORALINFLATIONRATES)TISTHEREFORE IMPORTANT TO CHECK WHETHER THE TIMING OF THE &INALLY LOOKING AT A LARGE NUMBER OF /%#$ ESTIMATED BREAKS IS PLAUSIBLY ASSOCIATED WITH COUNTRIESTHEREAPPEARTOBETHREEMAINhWAVESv OFBREAKSINTHEMEANOFINFLATIONTHEFIRSTIN SHIFTSINMONETARYPOLICYREGIMES THELATESOREARLYSTHESECONDINTHE 4HEREARETHREEPIECESOFEVIDENCETHATSUGGEST MIDS AND THE THIRD IN THE EARLY S THAT THE BREAKS IN THE MEAN OF INFLATION COULD HAVEBEENASSOCIATEDWITHSHIFTSINTHEMONETARY 2OBALO-ARQUES$OSSCHEAND%VERAERT#ECCHETTI AND$EBELLE POLICYREGIME&IRSTTHETIMINGOFTHEBREAKSIN /2EILLYAND7HELANFINDTHATTESTSBASEDONASYMPTOTIC THE MEAN OF INFLATION OFTEN CORRESPONDS TO DISTRIBUTIONSOVERSTATETHEEVIDENCEFORBREAKSINTHEIRSAMPLE ANNOUNCED SHIFTS IN THE MONETARY POLICY SUCHTHATACAREFULECONOMETRICTREATMENTOFTHEBREAKTESTSIS CALLEDFOR'ADEAAND-AYORALSIMILARLYARGUETHATTHERE REGIME 4HISISMOSTCLEARINTHOSECOUNTRIES IS A DANGER OF CONFUSION BETWEEN STRUCTURAL BREAKS AND HIGH WHERE THERE WAS A CLEAR BREAK IN MONETARY PERSISTENCE USING MODELS OF FRACTIONALLY INTEGRATED PROCESSES THAT DO NOT EXPLICITLY CONTROL FOR CHANGES IN THE MEAN BUT POLICYSUCHASTHEANNOUNCEMENTOFANINFLATION MODEL INFLATION AS A PROCESS THAT CAN DEVIATE FOR LONG TIME TARGETINGREGIME!SANILLUSTRATION&IGURE PERIODSFROMITSLONGRUNMEANWHILERETURNINGTOITEVENTUALLY SHOWS THE TIME PROFILE OF EURO AREA INFLATION THEY FIND THAT INFLATION IS HIGHLY PERSISTENT IN /%#$ COUNTRIES OVER TIME WHERE INFLATION IS CALCULATED 3EEFOREXAMPLE,EVINAND0IGER QUARTERLYNONANNUALISEDANDESTIMATESFORITS 3EE !UCREMANNE AND #OLLIN FOR "ELGIUM AND "ILKE FOR&RANCE MEANCONDITIONALONONEBREAK4HEREISSTRONG 11 These waves are associated mainly with breaks in the mean of nominal rather than real variables, which can be taken as evidence that all three waves are related to monetary policy. 14 In sum, there is evidence that the breaks in the mean of inflation are (at least partly) related to changes in monetary policy regimes, such that estimates of inflation persistence for the current regime should explicitly address the existence of such breaks in order not to overestimate persistence. These findings are robust in analysing different def initions of inflation. However, it is noteworthy that inflation persistence is considerably higher for measures of core inflation when compared to headline inflation – as indicated, for example, by the last row in Table 3.2. This issue will be addressed further in an analysis of sectoral differences in persistence in Section 3.3 below. Finally, there is evidence that inflation persistence has dropped in recent times, a development which has not been restricted to the euro area, but has also been noted in other countries. 15 Overall, the evidence presented in this section suggests that once shifts in the monetary policy regime are taken into account, the degree of inflation persistence in the euro area is not very high. However, the precise degree of persistence is difficult to assess due to the considerable uncertainty associated with it. These results are consistent with those found in the literature for other, non-euro area economies. It is important to account for structural breaks in the mean of inflation – for which there is ample statistical evidence. Doing so reduces the estimated degree of inflation persistence considerably, leading to a confirmation of the evidence for the euro area that inflation persistence is best described as moderate. Table 3.2 shows some results from models for a number of countries, allowing for a break in the mean of inflation and including a variety of inflation indicators for each of them. It is apparent that in most cases the hypothesis of the most extreme form of persistence can be rejected, and that most parameters are relatively low. Not unexpectedly, persistence is estimated to be higher for the “smoother” series of core inflation. As a matter of fact, it is only for core inflation in the United States and Switzerland that the most extreme form of persistence cannot be rejected. 3.2 EVIDENCE FROM STRUCTURAL MODELS OF INFLATION DYNAMICS The estimates of inflation persistence reported in the preceding sections originated from simple univariate models of inflation. As such, these models cannot distinguish between the various types of inflation persistence defined in 14 See Corvoisier and Mojon (2005). 15 See Angeloni, Aucremanne and Ciccarelli (2005) for the euro area, as well as Benati (2002) and Cogley and Sargent (2001). Table 3.2 Estimated inflation persistence for various countries GDP deflator CPI inflation Core CPI inflation PCE price inflation Australia Canada Japan New Zealand Sweden Switzerland United Kingdom United States 0.54 0.47 0.59 0.16 -0.06 0.73 0.12 0.37 0.53 0.34 0.04 0.57 0.35 0.74 0.53 0.39 0.58 0.48 0.81 0.61 0.82 0.93 0.57 0.89 0.35 -0.09 0.72 0.60 0.39 0.92 0.55 0.39 Memo: Euro Area 0.60 0.60 0.80 Country Notes: Source: Levin and Piger (2004), Gadzinski and Orlandi (2004) for the euro area. 1984-2003. Parameters in bold indicate that it is possible to reject statistically that U = 1. PCE denotes personal consumption expenditure. 12 Table 3.3 Estimated inflation persistence in structural models Country Angeloni & Ehrmann Belgium Germany Greece Spain France Ireland Italy Luxembourg The Netherlands Austria Portugal Finland Euro Area Benigno & Galí, Gertler & Lopez-Salido Lopez-Salido Jondeau & Le Bihan McAdam & Willman Paloviita Rumler Sondergaard 0.35; 0.74 0.46 0.43 0.42 0.45 0.40 0.10 0.28 0.52; 0.41 0.67 0.37 0.09; 0.04 0.15; 0.57 0.50 0.30; 0.31 0.52; 0.55 0.37; 0.35 0.30 0.54 0.45 0.46 0.04; 0.27 0.26; 0.26 0.22; 0.40 0.44; 0.64 0.49; 0.72 Notes: Angeloni and Ehrmann (2004): 1998:I-2003:II. Benigno and Lopez-Salido (2002): 1970:I-1997:I. Galí, Gertler and Lopez-Salido (2001): 1970:I-1998:II. Jondeau and Le Bihan (2005): 1970:I-1999:IV. McAdam and Willman (2004): 1970:I-1997:IV. Paloviita (2004): 1977-2003. Rumler (2005): 1970:I-1998:IV. Sondergaard (2004): 1979:II-2001:III. Two parameters per country and study are provided if the studies offer alternative results. Section 2. More structural models of inflation persistence are necessary for this purpose. Interestingly, the finding of moderate persistence is also borne out by estimates of the degree of intrinsic inflation persistence in structural models. In a structural time-series model, it has been shown that after correcting for changes in the long-run value of inflation, intrinsic persistence is moderate, and the major sources of persistence are expectations-based and extrinsic. 16 Results from estimating New Keynesian Phillips curves, such as those in the model introduced in Section 2, are reported in Table 3.3. This table contains estimates for the degree to which inflation is backward-looking and as such intrinsically persistent. 17 in generating inflation persistence: by incorporating real wage rigidities, i.e. the slow adjustment of real wages to underlying labour market conditions, in the New Keynesian Phillips Curve framework, the model fits the data better. 19 These findings are consistent with the evidence from other countries such as the United States, that there is some role for “backwardlookingness” in inflation, which is reduced when looking at the more recent period. For example, for the United States, the weight on the backward-looking component becomes insignificant when the post-Volcker sample period is considered. 20 Furthermore, there is direct evidence for the United States and Canada that shifts in long-term inflation expectations Several results emerge. First, under the assumption of rational expectations, all studies find that there is a significant role for “backwardlookingness” in inflation, and thus for intrinsic inflation persistence, but the coefficient is generally less than 0.5. Second, in line with the evidence reported above, also structural models find that the degree of intrinsic persistence drops when estimated over more recent samples, over stable monetary policy regimes, or when allowing for a time-varying inflation target. 18 Also, in the context of these models, there is evidence for an important role of labour markets 16 See Dossche and Everaert (2005). 17 The estimates relate to slightly different versions of the New Keynesian Phillips curve than used in Section 2 and explained in footnote 5. In particular, they model inflation rate as dependent on μ̂ t , the deviation of actual from desired markup and ξ t , an exogenous mark-up shock. The model is therefore Table 3.3 reports the parameter γ . 18 Coenen and Wieland 2005; Coenen and Levin 2004; de Walque, Smets and Wouters 2004; Paloviita (2004). 19 Blanchard and Gali (2005), Christoffel and Linzert (2005). Christoffel, Kuester and Linzert (2005) show that wage rigidities affect the dynamic response of inflation to a monetary policy shock. 20 Gali and Gertler (1999). 13 HAVE CONTRIBUTED SIGNIFICANTLY TO INFLATION PERSISTENCESUPPORTINGTHEIDEATHATBREAKSIN THE MEAN OF INFLATION SHOULD BE DISENTANGLED FROM THE BEHAVIOUR OF INFLATION IN OTHER TIMES CONSTITUTE A MAJOR SOURCE OF THE VARIABILITY OF ACTUALINFLATION-OREOVERGIVENTHATINFLATION EXPECTATIONS ADJUST TO NEW INFORMATION ONLY GRADUALLY EXPECTATIONSBASED PERSISTENCE CAN BEGENERATED 4(%2/,%/&).&,!4)/.%80%#4!4)/.3 4HE ESTIMATES REPORTED ABOVE ASSUME THAT EXPECTATIONS ARE FORMED RATIONALLY /NE EXPLANATION FOR THE PRESENCE OF BACKWARD LOOKINGTERMSINASTANDARD0HILLIPSCURVEMAY BETHATEXPECTATIONSAREPARTLYBASEDONLAGGED INFLATION)THASBEENSHOWNTHATINECONOMIES WHERE CENTRAL BANKS HAVE ADOPTED EXPLICIT INFLATION OBJECTIVES LONGTERM INFLATION EXPECTATIONSHAVEBEENSUCCESSFULLYANCHORED !CCORDINGLY INFLATION EXPECTATIONS ARE NOT RELATEDTOPASTINFLATIONINTHESEECONOMIESAND ACTUALINFLATIONDEVELOPMENTSARELESSPERSISTENT )N THIS CONTEXT CENTRAL BANK TRANSPARENCY IS A CRUCIALFACTOR)NCONTRASTINFLATIONPERSISTENCE ISLIKELYTOBEHIGHERWHENPRIVATEAGENTSHAVE LIMITED INFORMATION ABOUT THE CENTRAL BANKS OBJECTIVES)NSUCHASETTINGTHEAGENTSWILLTRY TODISENTANGLEPERSISTENTSHIFTSINTHEINFLATION OBJECTIVEFROMTRANSITORYDISTURBANCESANDWILL MANAGE TO DO SO MORE QUICKLY THE MORE TRANSPARENTANDCREDIBLETHECENTRALBANK 4HESE RESULTS SUGGEST THAT IT IS IMPORTANT TO UNDERSTAND WHAT DETERMINES INFLATION EXPECTATIONS ! PROMISING APPROACH IS TO ASSUMETHATPRIVATEAGENTSUSERELATIVELYSIMPLE RECURSIVELEARNINGALGORITHMSTOFORMINFLATION EXPECTATIONS IN THE PRESENCE OF MODEL UNCERTAINTY)THASBEENFOUNDINPARTICULARTHAT ACTIVIST CENTRAL BANKS THAT CARE A LOT ABOUT STABILISING THE OUTPUT GAP MAY SLOW DOWN THE LEARNING PROCESS OF AGENTS AND MAY THEREBY INCREASETHEPERSISTENCEOFTHEINFLATIONPROCESS )N THIS CASE THE MONETARY POLICY REGIME WILL AFFECT THE FORMATION OF INFLATION EXPECTATIONS AND THROUGH THIS CHANNEL ALSO INFLATION PERSISTENCE 'ENERALLY SPEAKING A CREDIBLE POLICY REGIME FOCUSED ON PRICE STABILITY WILL REDUCE THE PERSISTENCE OF INFLATION )T IS CLEAR THAT UNDER SUCH LEARNING SCHEMES IT IS PARTICULARLY IMPORTANT FOR A CENTRAL BANK TO ANCHORINFLATIONEXPECTATIONS ! DIRECT TEST OF THE IMPORTANCE OF INFLATION EXPECTATIONSFORTHEDYNAMICSOFINFLATIONCAN BE CONDUCTED IN THE FRAMEWORK OF STRUCTURAL MODELS OF INFLATION DYNAMICS BY USING DIRECT MEASURES OF INFLATION FORECASTS OBTAINED FOR EXAMPLE FROM THE 3URVEY OF 0ROFESSIONAL &ORECASTERSFORTHE5NITED3TATESANDFROMTHE /%#$ FOR THE EURO AREA RATHER THAN THE ASSUMPTION OF RATIONAL OR MODELCONSISTENT EXPECTATIONS 3UCH STUDIES FIND THAT THE ROLE FOR EXPLICIT BACKWARDLOOKING INFLATION BEHAVIOUR AND THUS INFLATION PERSISTENCE IS SIGNIFICANTLY FURTHER REDUCED IF ONE ALLOWS FOR THEFACTTHATEXPECTATIONSARENOTFULLYRATIONAL #ONSISTENT WITH THIS OVERALL PICTURE IT IS ALSO FOUNDTHATINFLATIONHASBECOMEMOREFORWARD LOOKINGINRECENTYEARSANDTHATITHADALREADY BEENMOREFORWARDLOOKINGPRIORTOTHEINCEPTION OF%-5INTHECOUNTRIESWITHLOWINFLATION)T ALSO TURNS OUT THAT CHANGES IN EXPECTATIONS 14 /VERALLTHEEVIDENCEFROMASTRUCTURALESTIMATION OFTHE.EW+EYNESIAN0HILLIPSCURVEFORTHEEURO AREA SUGGESTS THAT THE FORWARDLOOKING TERM IS DOMINANTSUGGESTINGTHATINFLATIONPERSISTENCE IS MOSTLY EXTRINSIC OR DRIVEN BY PERSISTENCE IN ITSPROXIMATEDETERMINANTS4HEREISEVIDENCEOF A BACKWARDLOOKING COMPONENT INTRINSIC INFLATIONPERSISTENCEBUTTHISBACKWARDLOOKING COMPONENT MAY BE PARTLY DUE TO THE LEARNING BEHAVIOUR OF PRICESETTERS AND IS THEREFORE NOT INVARIANT TO THE MONETARY POLICY REGIME )N PARTICULARWHENINFLATIONEXPECTATIONSAREWELL ANCHOREDPASTINFLATIONDEVELOPMENTSARELIKELY TOBELESSIMPORTANTINSHAPINGFUTUREINFLATION +OZICKIAND4INSLEY %RCEG AND ,EVIN ,EVIN .ATALUCCI AND 0IGER 2AVENNAVANDER#RUIJSENAND$EMERTZIS 3EE FOR EXAMPLE 2OBERTS !DAM AND 0ADULA 0ALOVIITA 0ALOVIITAAND6IRÏN /RPHANIDES AND 7ILLIAMS 'ASPAR 3METS AND 6ESTIN (%4%2/'%.%)49!#2/33#/5.42)%3!.$ 3%#4/23 ).&,!4)/.0%23)34%.#%).4(%%52/!2%! #/5.42)%3 (OWDOESTHEEVIDENCEONTHEEUROAREACOMPARE WITH THAT FOR INDIVIDUAL EURO AREA COUNTRIES 4HE ANSWER TO THIS QUESTION IS GIVEN IN 4ABLE WHICH REPORTS THE RESULTS AVAILABLE AT THE COUNTRY LEVEL 'IVEN THE FINDINGS REPORTED ABOVETHETABLEINCLUDESONLYSTUDIESTHATALLOW FOR A CHANGE IN THE MEAN OF INFLATION OR ARE ESTIMATED OVER A RELATIVELY SHORT TIME SAMPLE 4HE TABLE DISTINGUISHES BETWEEN STUDIES USING #0) DATA AND THOSE USING ()#0 DATA AS THIS DISTINCTION TURNS OUT TO BE IMPORTANT FOR THE LEVELOFINFLATIONPERSISTENCE-OSTLIKELYDUETO THE INCLUSION OF SALES PRICES IN THE ()#0 MEASURESOFPERSISTENCEARECONSIDERABLYLOWER FOR THIS INDEX THAN FOR #0) DATA AN ISSUE THAT WILLBELOOKEDATFURTHERBELOWINTHECONTEXTOF SECTORALESTIMATES 4HREE RESULTS EMERGE &IRST THERE IS A CONSIDERABLE DEGREE OF HETEROGENEITY ACROSS COUNTRIESnWITHINEACHSTUDYTHEESTIMATESFOR INFLATION PERSISTENCE VARY MARKEDLY 3ECOND THERE IS ALSO A WIDE RANGE OF ESTIMATES ACROSS STUDIES AND THE STUDIES DISAGREE CONSIDERABLY ON THE COUNTRY RANKINGS 4HIS SENSITIVITY OF RESULTS ACROSS STUDIES AND THUS TO SAMPLE PERIODSANDECONOMETRICMETHODSIMPLIESTHAT THERE IS A CONSIDERABLE DEGREE OF UNCERTAINTY ABOUT THE TRUE DEGREE OF INFLATION PERSISTENCE 4HIRD FOR THE VAST MAJORITY OF CASES IT IS POSSIBLE TO REJECT THE HYPOTHESIS OF EXTREME PERSISTENCEASINDICATEDBYTHELARGENUMBEROF PARAMETERS IN BOLD PRINT "EYOND THAT THE PARAMETERS REPORTED ARE GENERALLY VERY LOW POINTING TO A MODERATE LEVEL OF PERSISTENCE AT THECOUNTRYLEVEL ).&,!4)/.0%23)34%.#%!44(%3%#4/2!,,%6%, 'OINGDOWNONEMORELEVELOFAGGREGATIONITIS POSSIBLETOANALYSETHEEXTENTTOWHICHINFLATION IS PERSISTENT IN THE DIFFERENT SECTORS OF THE ECONOMY4ABLECONTAINSASECTORALANALYSIS FORTHEEUROAREAESTIMATEDFORTHEPERIOD /VERALLTHEREAREONLYVERYFEWSECTORS FORWHICHTHEHYPOTHESISOFEXTREMEPERSISTENCE CANNOT BE REJECTED AS INDICATED BY THE LARGE NUMBEROFPARAMETERSINBOLDPRINT4HISTABLE HELPS TO CLARIFY WHY SOME OF THE ESTIMATED PERSISTENCE MEASURES IN THE PREVIOUS SECTION WERENEGATIVE4HEINCLUSIONOFSALESPRICESIN THECOMPILATIONOFTHE()#0AFFECTSTHEMEASURED DEGREE OF INFLATION PERSISTENCE SUBSTANTIALLY PARTICULARLY WHEN ESTIMATED OVER THE RECENT PERIOD FOR WHICH THE OBSERVATIONS AFFECTED BY THIS METHODOLOGICAL CHANGE ARE DOMINANT ! 4ABLE%STIMATEDINFLATIONPERSISTENCEFORTHEEUROAREACOUNTRIES #OUNTRY "ELGIUM 'ERMANY 'REECE 3PAIN &RANCE )RELAND )TALY ,UXEMBOURG 4HE.ETHERLANDS !USTRIA 0ORTUGAL &INLAND #0) !UCREMANNE #OLLIN "ILKE ()#0 'ADZINSKI (ONDROYIANNIS /RLANDI ,AZARETOU ,EVIN 0IGER #ECCHETTI $EBELLE ,àNNEMANN -ATHÊ .OTES0ARAMETERSINBOLDINDICATETHATITISPOSSIBLETOREJECTSTATISTICALLYTHAT U !UCREMANNEAND#OLLIN)))6 "ILKE(ONDROYIANNISAND,AZARETOU))),EVINAND0IGER#ECCHETTIAND $EBELLE$ATASTARTSIN'ADZINSKIAND/RLANDI)))),àNNEMANNAND-ATHÊ 15 4ABLE%STIMATEDINFLATIONPERSISTENCEAT THESECTORALLEVEL U 3ECTOR &OODNONALCOHOLICBEVERAGES !LCOHOLICBEVERAGESTOBACCONARCOTICS #LOTHINGFOOTWEAR (OUSINGWATERELECTRICITYGASOTHERFUELS &URNISHINGSHOUSEHOLDEQUIPMENTS (EALTH 4RANSPORTATION #OMMUNICATIONS 2ECREATIONCULTURE %DUCATION 2ESTAURANTSHOTELS -ISCELLANEOUSGOODSSERVICES 3OURCE,àNNEMANNAND-ATHÊ0ARAMETERSIN BOLDINDICATETHATITISPOSSIBLETOREJECTSTATISTICALLYTHATU SECTOR WHICH IS HEAVILY AFFECTED BY ENDOF SEASON SALES IS CLOTHING AND FOOTWEAR n WHICH IS ALSO THE SECTOR THAT HAS A NEGATIVE » IN 4ABLE !CCORDINGLY IT MIGHT BE USEFUL TO REPEAT SUCH ANANALYSISFORAMOREEXTENDEDPERIODOFTIME ANDORUSING#0)RATHERTHAN()#0MEASURESTO AVOIDTHEDOMINANCEOFSALESPRICESINESTIMATES OFPERSISTENCE4HERESULTSOFTWOSUCHEXERCISES ARE REPORTED IN 4ABLE AT A SLIGHTLY MORE AGGREGATED SECTORAL BREAKDOWN4HERE IS CLEAR EVIDENCE OF CONSIDERABLE HETEROGENEITY ACROSS SECTORS)NMOSTCASESNONPROCESSEDFOODAND ENERGYARELITTLEPERSISTENTONTHEONEHANDAND SERVICES AND INDUSTRIAL GOODS ARE HIGHLY PERSISTENT ON THE OTHER #OMPARING CROSS COUNTRY WITH CROSSSECTOR HETEROGENEITY IT APPEARSTHATTHELATTERISMOREPRONOUNCED 4(%2/,%/&!$-).)34%2%$02)#%3 4HEDIFFERENCESININFLATIONPERSISTENCEACROSS SECTORS MOST LIKELY REFLECT IN PARTS DIFFERENT PRICE SETTING PRACTICES THAT DEPEND ON THE VARIOUS MARKET STRUCTURES IN WHICH FIRMS OPERATE!POTENTIALLYLARGEDIFFERENCEINPRICE SETTING PRACTICES CAN BE EXPECTED IF PRICES ARE NOTMARKETDETERMINEDBUTADMINISTEREDWHICH IN ITSELF MIGHT BE AN OUTCOME OF PARTICULAR MARKET STRUCTURES OR OTHER RELEVANT FACTORS (OWEVER IN ORDER TO ANALYSE THIS ISSUE IT IS NECESSARY TO FIND A MEASURE OF ADMINISTERED PRICESASTHEREISNOREADILYAVAILABLEINDEX 6ARIOUSFACTORSCOMPLICATETHECONSTRUCTIONOF SUCHANINDEX&IRSTTHEREISALARGEVARIETYOF ADMINISTRATIVE MEASURES 3ECOND SOME MEASURES APPLY ONLY AT THE REGIONAL OR LOCAL LEVEL OR DEPEND ON CHARACTERISTICS OF THE CONSUMER!POSSIBLEWAYFORWARDISTHEREFORE TO IDENTIFY THE SUBINDICES THAT ARE CONSIDERED TOBEHEAVILYINFLUENCEDBYADMINISTEREDPRICE SETTING)NMANYINSTANCESHOWEVERTHISIMPLIES AGGREGATING ADMINISTERED PRICES AS WELL AS MARKETDETERMINEDONESACAVEATTHATNEEDSTO BE BORNE IN MIND WHEN ANALYSING RESULTS OBTAINEDATTHESUBINDEXLEVEL !LTHOUGH CHANGES IN ADMINISTERED PRICES CAN HAVEASIZEABLEIMPACTONTHELEVELOFINFLATION THISDOESNOTNECESSARILYIMPLYTHATGOODSAND SERVICES WITH ADMINISTERED PRICES SHOW A DIFFERENT DEGREE OF INFLATION PERSISTENCE )T HOLDSTRUETHATADMINISTEREDPRICESCHANGELESS FREQUENTLYANDBYLARGERAMOUNTSTHANMARKET 3EEALSO%#" 4HISHASBEENSHOWNFOREXAMPLEIN%#" 4ABLE%STIMATEDINFLATIONPERSISTENCEATTHESECTORALLEVEL "ELGIUM 'ERMANY )TALY %URO!REA !# !-: "ILKE !-: !-: !-: .ONPROCESSEDFOOD %NERGY 0ROCESSEDFOOD 3ERVICES )NDUSTRIALGOODS &RANCE 3OURCE!#!UCREMANNE#OLLIN!-:!LTISSIMO-OJON:AFFARONI"ILKE 16 DETERMINEDONES)TISALSOTHECASETHATINFLATION MEASURESEXCLUDINGADMINISTEREDPRICESSHOWA SOMEWHATSMALLERDEGREEOFINFLATIONPERSISTENCE nHOWEVERTHEREDUCTIONISRELATIVELYSMALL&OR INSTANCEATTHEEUROAREALEVELTHEESTIMATEFOR » DECREASES FROM TO WHEN ESTIMATED OVER THE TIME PERIOD STARTING FROM THE SECOND QUARTER OF 4HIS MIGHT REFLECT THE RELATIVELY SMALL WEIGHT OF GOODS AND SERVICES WITH ADMINISTERED PRICES IN THE OVERALL INDEX 4HEEVIDENCEFORTHEEUROAREAISCORROBORATED BYEVIDENCEFORTHE53ECONOMY)NTHE5NITED 3TATESITISALSOFOUNDTHATREGULATEDPRICESARE ONAVERAGESLOWERTORESPONDTOCHANGESINCOST ANDDEMANDCONDITIONS !''2%'!4)/.%&&%#43 #OMPARINGTHESECTORALRESULTSIN4ABLEWITH THOSEATTHECOUNTRYLEVELIN4ABLEANDAGAIN THECOUNTRYRESULTSWITHTHEEUROAREAAGGREGATE RESULTS IT IS APPARENT THAT THE PERSISTENCE OF AGGREGATED INFLATION SERIES IS TYPICALLY HIGHER THAN THE AVERAGE OF THE PERSISTENCE OF ITS SUB COMPONENTS4HESE PATTERNS ILLUSTRATE HOW THE TIMESERIESPROPERTIESOFINFLATIONCANBESUBJECT TO AN AGGREGATION EFFECT 4HE AGGREGATION OF SUBINDICESTOANAGGREGATESERIESHASTWOMAIN EFFECTS THAT ARE RELEVANT IN OUR CONTEXT &IRST IDIOSYNCRATIC SHOCKS TO THE SUBINDICES WILL TENDTOWASHOUTIFTHEREISASUFFICIENTLYLARGE NUMBER OF SERIES THAT ARE AGGREGATED !CCORDINGLY AN ANALYSIS OF THE AGGREGATE WILL NOT BE AFFECTED BY SUCH IDIOSYNCRATIC SHOCKS ANDMAKETHESERIESAPPEARhSMOOTHERvASITIS MORE LIKELY TO BE DOMINATED BY THE COMMON SHOCKS ONLY 3ECOND THE PERSISTENCE OF THE AGGREGATE IS A COMPLEX FUNCTION OF THE PERSISTENCEOFTHESUBINDICESWHERETHEMORE PERSISTENT SERIES RECEIVE A RELATIVELY LARGER WEIGHT )T CAN BE SHOWN THAT BOTH EFFECTS ARE PRESENTANDIMPORTANT&OREXAMPLEONLYAROUND OFTHEVARIANCEOFSECTORALINFLATIONRATES ISEXPLAINEDBYACOMMONFACTORWITHTHEBULK OFTHEREMAINDERBEINGDRIVENBYSECTORSPECIFIC IDIOSYNCRATIC SHOCKS !GGREGATION OF THESE SECTORAL INFLATION RATES CAN THUS POTENTIALLY SMOOTHENOUTTHELARGESTFRACTIONINTHEVARIANCE OF INFLATION &URTHERMORE PERSISTENCE OF THE AGGREGATE WILL BE HIGHER DUE TO THE RELATIVELY 17 LARGER WEIGHT OF THE MORE PERSISTENT SUB INDICES !CCORDINGLYITISIMPORTANTTOKEEPIN MINDTHATEUROAREAINFLATIONTHEULTIMATEGOAL FORMONETARYPOLICYMIGHTWELLEXHIBITHIGHER PERSISTENCETHANITSINDIVIDUALCOMPONENTS 4(%-%#(!.)#3/&).$)6)$5!,02)#% !$*534-%.43 4HIS SECTION BRINGS TOGETHER THE RESULTS OF THE EMPIRICALANALYSESCONDUCTEDATTHEMICROLEVEL 4HE EVIDENCE COMES FROM TWO MAIN TYPES OF DATA SOURCES DESCRIBED IN DETAIL IN THE!NNEX 4HE FIRST TYPE OF DATA CONSISTS OF DIRECT INFORMATIONONINDIVIDUALPRICESATTHECONSUMER ANDTHEPRODUCERLEVEL5SINGTHESEMICRODATA THE )0. 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NUMBER OF INTERESTING STYLISED FACTS EMERGE FROMTHEANALYSISOFINDIVIDUALPRICERECORDS (ETEROGENEITY OF PRICESETTING BEHAVIOUR IS NOT ONLY IMPORTANT ACROSS PRODUCT CATEGORIES 02)#%3#(!.'%).&2%15%.4,9 THEREISALSOSUBSTANTIALHETEROGENEITYOFPRICE &IRST AS SHOWN IN 4ABLES AND PRICES SETTING BEHAVIOUR WITHIN PRODUCT CATEGORIES CHANGEINFREQUENTLY4HESHAREOFPRICESTHATARE !LTHOUGHTHEREISANOTABLEHETEROGENEITYACROSS CHANGEDEACHMONTHIETHEFREQUENCYOFPRICE COUNTRIESITISLESSIMPORTANTTHANCROSSSECTOR CHANGESISEQUALTOFORCONSUMERPRICESIN HETEROGENEITY4HESOURCEOFTHECROSSCOUNTRY THE EURO AREA AND EQUALS TO FOR VARIATION IS LIKELY TO BE PARTLY STRUCTURAL PRODUCER PRICES 4HE AVERAGE DURATION OF A DIFFERENCESINCONSUMPTIONSTRUCTUREOROUTLET CONSUMER PRICE SPELL RANGES FROM FOUR TO FIVE COMPOSITIONMETHODOLOGICALTHETREATMENTOF QUARTERSANDISSIMILARORSOMEWHATLOWERFOR SALESANDOFQUALITYADJUSTMENTBYEACH.3)OR PRODUCER PRICES 4HE ORDER OF MAGNITUDE OF DUETODIFFERENCESINTHERELATIVEIMPORTANCEOF THESE NUMBERS IS ROBUST TO VARIATIONS IN THEIR REGULATEDPRICESACROSSCOUNTRIES CALCULATION METHODS TO USING LARGER DATASETS WHENAVAILABLEORTOUSINGWEIGHTEDMEASURES ,OOKINGATTHEDIFFERENCESACROSSSECTORSTHERE &URTHERMORE IT IS ALSO CORROBORATED BY THE IS A VERY CLEAR PATTERN THAT PRICE CHANGES FOR SURVEYEVIDENCEWHICHSHOWSTHATTHEMEDIAN CONSUMERGOODSANDSERVICESAREVERYFREQUENT FIRMCHANGESPRICESLESSTHANONCEAYEAR FORENERGYOILPRODUCTSANDUNPROCESSEDFOOD WHEREASTHEYARERELATIVELYINFREQUENTFORNON 35"34!.4)!,$%'2%%/&(%4%2/'%.%)49 ENERGY INDUSTRIAL GOODS AND PARTICULARLY 3ECOND THERE IS A SUBSTANTIAL DEGREE OF SERVICES4HISISILLUSTRATEDIN4ABLEWHICH HETEROGENEITYINTHEFREQUENCYOFPRICECHANGES SHOWS THAT THE EURO AREA COUNTRIES SHARE A ACROSS PRODUCTS 4HIS IS ILLUSTRATED IN &IGURE COMMONRANKINGOFTHEFIVEMAINCOMPONENTS WHICHSHOWSTHEUNWEIGHTEDDISTRIBUTIONOF OFTHE#0)ACCORDINGTOTHEIRFREQUENCYOFPRICE THE CALCULATED FREQUENCY OF CONSUMER PRICE CHANGES %NERGY PRICES AND UNPROCESSED FOOD CHANGESFOREACHPRODUCTINEACHCOUNTRY4HE PRICES CHANGE VERY OFTEN AND FIGURE ILLUSTRATES THAT MOST PRODUCTS CLUSTER IN RESPECTIVELY MOSTLY IN RESPONSE TO FREQUENT THE RANGE OF AND THUS AROUND THE 4HE RESULTS ARE MAINLY BASED ON &ABIANI ET AL -ORE CALCULATED MEAN OF BUT THAT THERE ARE DETAILED RESULTS ARE PROVIDED IN THE VARIOUS NATIONAL PAPERS ALSOQUITEAFEWPRODUCTSWHICHCHANGEPRICES PRODUCED IN THE )0. !UCREMANNE AND $RUANT FOR "ELGIUM«LVAREZAND(ERNANDOFOR3PAIN,OUPIASAND VERYFREQUENTLYASINDICATEDBYTHEOBSERVATIONS 2ICART FOR &RANCE &ABIANI ET AL FOR )TALY ATTHERIGHTENDOFTHEFIGURE (OEBERICHTSAND3TOKMANFORTHE.ETHERLANDS+WAPILET ALFOR!USTRIAAND-ARTINSFOR0ORTUGAL 18 4ABLE&REQUENCYOFCONSUMERPRICECHANGESBYPRODUCTTYPEIN #OUNTRY "ELGIUM 'ERMANY 3PAIN &RANCE )TALY ,UXEMBOURG 4HE.ETHERLANDS !USTRIA 0ORTUGAL &INLAND %URO!REA 5NPROCESSED FOOD 0ROCESSED FOOD %NERGY OIL PRODUCTS .ONENERGY INDUSTRIAL GOODS 3ERVICES 4OTAL COUNTRY WEIGHTS NA 4OTAL %UROAREA WEIGHTS 3OURCE$HYNEETAL&IGURESPRESENTEDINTHISTABLEARECOMPUTEDONTHEBASISOFTHEPRODUCTSAMPLEWITHTHEONLYEXCEPTION OF&INLANDFORWHICHFIGURESBASEDONTHEENTIRE#0)AREPRESENTED4HETOTALWITHCOUNTRYWEIGHTSISCALCULATEDUSINGCOUNTRYSPECIFIC WEIGHTSFOREACHITEMTHETOTALWITHEUROAREAWEIGHTSUSINGCOMMONEUROAREAWEIGHTSFOREACHSUBINDEX.OFIGURESAREPROVIDED FOR&INLANDBECAUSEOFALACKOFCOMPARABILITYOFTHESAMPLEOFPRODUCTSUSEDINTHISCOUNTRY CHANGES IN INPUT PRICES 'IVEN THE RELATIVE IMPORTANCE OF SUPPLY SHIFTS IN THOSE SECTORS THISRESULTISNOTSURPRISINGUNDERTHEASSUMPTION THATPRICESARERESETINRESPONSETOSUCHSHIFTS 4HESE TWO PRODUCT TYPES ARE FOLLOWED BY PROCESSED FOOD AND NONENERGY INDUSTRIAL GOODS 0RICES OF SERVICES CHANGE LESS OFTEN THE AVERAGE FREQUENCY OF PRICE CHANGES IS )NTERESTINGLY THERE IS ALSO A MAPPING BETWEEN PRICE STICKINESS AND GRADUALISM IN THE SENSE THAT SECTORS CHANGING PRICES INFREQUENTLY EXHIBIT A MORE GRADUAL ADJUSTMENTPATTERNWHEREBYPRICEINCREASESARE FOLLOWED BY FURTHER PRICE INCREASES TAKING ACCOUNTOFTHELONGERTIMESPANTHATHASELAPSED SINCETHELASTPRICECHANGE ! 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3OURCE6ERMEULENETAL 19 ROWS AND OF4ABLE )N THE UNPROCESSED FOOD SECTOR PRICE CHANGES ARE NOT ONLY VERY FREQUENTTHEYAREALSOVERYLARGEATAND RESPECTIVELYFORPRICEINCREASESANDDECREASES 0RICE INCREASES ARE THUS SLIGHTLY SMALLER BUT SLIGHTLY MORE FREQUENT SUCH THAT ON AVERAGE PRICEINCREASESANDDECREASESNEARLYOFFSETEACH OTHER4HISISCONSISTENTWITHTHENOTIONTHATTHE PRICING STRUCTURE IS DOMINATED BY SUPPLYSIDE FACTORS SUCH AS THE SEASONAL NATURE OF MANY UNPROCESSED FOOD ITEMS )N A SIMILAR VEIN THE FREQUENT PRICE CHANGES FOR ENERGY GOODS ARE CONSISTENTWITHTHEVARIABILITYOFMARGINALCOSTS IE OIL PRICES4HE RELATIVELY SMALLER SIZE OF PRICECHANGESMIGHTBERELATEDTOTHEFACTTHAT PRICESOFENERGYPRODUCTSCHANGEAROUNDTHREE TIMESASOFTENTHANTHOSEFORUNPROCESSEDFOOD ASWELLASPOSSIBLYDIFFERENCESINTHESIZEOFTHE SHIFTSINTHEUNDERLYINGFACTORS 02)#%$%#2%!3%3!2%./45.#/--/. 4HIRD AND SOMEWHAT SURPRISINGLY PRICE DECREASESARENOTUNCOMMONEXCEPTINSERVICES /NAVERAGEAROUNDOFBOTHCONSUMERAND PRODUCER PRICE CHANGES ARE PRICE REDUCTIONS %VEN 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PRICE CHANGES FURTHERMORESIMILARTOWHATISOBSERVEDINTHE EURO AREA OF ALL PRICE CHANGES ARE PRICE DECREASES IN THE 5NITED 3TATES AND PRICE CHANGES ARE LARGE RELATIVE TO THE PREVAILING !#/-0!2)3/.7)4(/4(%2%#/./-)%3 INFLATIONRATEWITHWHENSALESPRICES 4HE ECONOMY FOR WHICH MOST EVIDENCE ON THE ARENOTTAKENINTOACCOUNT PATTERNSOFPRICEADJUSTMENTISAVAILABLEISTHE 5NITED3TATES4HEMAINDIFFERENCEBETWEENTHE !LSO WHEN LOOKING AT THE FREQUENCY OF PRICE EURO AREA AND THE 5NITED 3TATES LIES IN THE CHANGES FOR PRODUCER PRICES THE EURO AREA IS FREQUENCY OF CONSUMER PRICE ADJUSTMENTS NOT VERY DIFFERENT FROM THE 5NITED 3TATES !S 7HEREASTHEFREQUENCYOFPRICECHANGESFORTHE THEREISNORESEARCHUSINGQUANTITATIVEDATAON EURO AREA HAS BEEN ESTIMATED AT SIMILAR PRODUCER PRICES FOR THE 5NITED 3TATES ESTIMATESFORTHE5NITED3TATESAREMUCHHIGHER COMPARISONSNEEDTOBEMADEUSINGTHESURVEY ATOVERTHEPERIODFROMTO RESULTS4HEFINDINGFORTHEEUROAREATHATFIRMS CONSIDERINGONLYTHEPRODUCTSSAMPLEFORTHE CHANGEPRICESAROUNDONCEAYEARISINLINEWITH EURO AREA 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THAN THE CORRESPONDING FIGURE FOR THE 5NITED 3TATESWHICHSTANDSATTWOQUARTERS(OWEVER THESE LARGE DIFFERENCES NEED NOT ONLY REFLECT "ILSAND+LENOW DIFFERENCES IN THE UNDERLYING PATTERNS OF PRICE +LENOWAND+RYVTSOV 3URVEY RESULTS FOR #ANADA FIND A HIGHER FREQUENCY OF PRICE SETTING )T IS NOT ENTIRELY CLEAR WHETHER THE CHANGES WITH AROUND HALF OF #ANADIAN FIRMS CHANGING THEIR DATASETSAREENTIRELYCOMPARABLE&URTHERMORE PRICESATLEASTONCEEVERYTHREEMONTHS(OWEVERTHISDIFFERENCE NEEDSQUALIFYINGASTHESURVEYDESIGNFOR#ANADADIFFERSFROM IF AN ECONOMY IS SUBJECT TO LARGER AND MORE THOSECONDUCTEDFORTHEEUROAREA)NTHESURVEYSCONDUCTEDBY FREQUENT SHOCKS ONE SHOULD EXPECT PRICE THE)0.DIFFERENTPRICESCHARGEDTODIFFERENTCUSTOMERSDUETO PRICEDISCRIMINATIONARENOTCONSIDEREDAPRICECHANGEWHEREAS CHANGES TO BE RELATIVELY MORE FREQUENT THEYAREINTHE#ANADIANSURVEY'IVENTHEIMPORTANCEOFPRICE $IFFERENCES BETWEEN THE EURO AREA AND THE DISCRIMINATION IN THE EURO AREA SEE BELOW CONSIDERING SUCH 5NITED 3TATES COULD THEREFORE TO SOME 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SHOWTHEPROBABILITYOFADJUSTINGAPRICECONDITIONALONTHEPRICE SEASONALPATTERNS)NGENERALPRICECHANGESARE HAVING BEEN UNCHANGED FOR A CERTAIN NUMBER OF PERIODS MORELIKELYTOTAKEPLACEDURINGTHEFIRSTQUARTER )NTUITIVELYONEWOULDEXPECTTHATSUCHAFUNCTIONTOBEUPWARD SLOPING IN TIME THE LONGER A PRICE HAS NOT BEEN CHANGED THE ESPECIALLY IN *ANUARY OR AFTER THE SUMMER MORELIKELYITISTHATITWILLBECHANGEDATAGIVENPOINTINTIME PERIOD ESPECIALLY IN 3EPTEMBER AND ARE LESS )NSTEADTHEESTIMATEDHAZARDFUNCTIONSAREGENERALLYDECREASING FREQUENTIN*ULYAND!UGUSTWITHTHEEXCEPTION OVER TIME 4HIS CAN BE RECONCILED HOWEVER IF THE HAZARD FUNCTIONS HAVE BEEN OBTAINED BY AGGREGATING HETEROGENEOUS OF&RANCEWHEREPRICECHANGESARELESSFREQUENT POPULATIONS4HELARGEDEGREEOFHETEROGENEITYOFPRICESETTING IN $ECEMBER 4HE HIGHER FREQUENCY OF PRICE BEHAVIOURACROSSANDWITHINPRODUCTSSUGGESTSTHATHETEROGENEITY INTHEDURATIONOFTHEDIFFERENTPRICESCOULDINDEEDBEATTHEROOT CHANGESASSOCIATEDWITH*ANUARYISPARTICULARLY OF THESE DECLINING HAZARDS «LVAREZ "URRIEL AND (ERNANDO OBSERVEDFORSERVICESFORINSTANCEIN"ELGIUM A 4AKING INTO ACCOUNT THE HETEROGENEITY OF PRODUCTS 0ORTUGALAND3PAIN)TISDIFFICULTTODETERMINE INDEED REDUCES THE NEGATIVE SLOPE OF THE HAZARD FUNCTION n ESTIMATINGDURATIONMODELSATAVERYHIGHLYDISAGGREGATEDLEVEL HOWEVERWHETHERTHISPATTERNPROVIDESEVIDENCE LEADSMOSTLYTONONDECREASINGHAZARDFUNCTIONS!UCREMANNE FOR STATEDEPENDENCE OR TIMEDEPENDENCE AS AND$HYNEA$IAS2OBALO-ARQUESAND3ANTOS3ILVA &OUGÒREETAL THE OBSERVED BEHAVIOUR CAN EITHER REFLECT 22 ACCUMULATED PRODUCTSPECIFIC INFLATION SINCE HIGHER FOR TRADE THAN FOR INDUSTRY EXCEPT FOR THEOCCURRENCEOFTHELASTPRICECHANGEFORTHIS )TALY4HEREISHOWEVERNOCLEARCUTEVIDENCE ON THE RELATIONSHIP BETWEEN PRICING RULES AND PRODUCTINTHEOUTLET THEDEGREEOFMARKETCOMPETITION4OSUMMARISE 3PECIALEVENTSSUCHASCHANGESININDIRECTTAXES THE EVIDENCE FOR PRODUCER PRICES CORROBORATES CANALSOBEEXPLOITEDTOGETABETTERUNDERSTANDING WHAT HAS BEEN FOUND FOR CONSUMER PRICES OFTHERULESDETERMININGPRICESETTINGBEHAVIOUR NAMELYTHATPRICESETTINGEVENIFPARTIALLYTIME AS THESE CAN BE CONSIDERED AS EXOGENOUS COST DEPENDENTISATTHESAMETIMESTATEDEPENDENT SHOCKS ANY IMPACT ON THE FREQUENCY OF PRICE INTHEPRESENCEOFSHOCKS CHANGESCANBEINTERPRETEDASEVIDENCEINFAVOUR OFSTATEDEPENDENTASPECTSOFPRICESETTING4HE !6!),!",%%6)$%.#%/.4(%2%!3/.3 &/23,5'')3(02)#%$9.!-)#3 EVIDENCEINTHISRESPECTISVERYROBUSTCHANGES IN INDIRECT TAXES ALWAYS LEAD TO TEMPORARY 7HEREASTHEPRECEDINGSECTIONSHAVEANALYSED INCREASESINTHEFREQUENCYOFPRICECHANGES THESTYLISEDFACTSOFPRICECHANGESANDTHERULES )N SUM ALTHOUGH THERE IS SOME EVIDENCE FOR THAT ARE FOLLOWED BY PRICESETTERS THIS SECTION TIMEDEPENDENCEWHICHWOULDLEADTOSTICKIER FOCUSESONPOTENTIALREASONSWHYPRICEDYNAMICS PRICESINTHEPRESENCEOFSHOCKSTHEREISATTHE ARESLUGGISH4HEMOSTDIRECTEVIDENCEONTHIS SAMETIMEACLEARPATTERNTHATFIRMSALSOCHANGE ISSUE CAN BE OBTAINED FROM THE SURVEYS ON THEIRPRICESINRESPONSETOCHANGESINUNDERLYING PRICING BEHAVIOUR &IVE OF THESE NAMELY FOR ECONOMICCONDITIONSPOINTINGTOTHEIMPORTANCE "ELGIUM )TALY ,UXEMBOURG !USTRIA AND 0ORTUGALPROVIDEDATAONTHEINFORMATIONSETON OFSTATEDEPENDENTPRICINGRULES WHICHFIRMSBASETHEIRPRICINGDECISIONSWHEN 4HIS FINDING IS CORROBORATED BY THE SURVEY THEY REVIEW THEIR PRICES 4HIS IS AN IMPORTANT RESULTSWHEREFIRMSWEREDIRECTLYASKEDABOUT PIECE OF EVIDENCE AS DEVIATIONS FROM FULLY THEIR PRICESETTING RULES 4ABLE SHOWS THAT OPTIMISING BEHAVIOUR CAN BE AN ADDITIONAL LESSTHANOFTHEFIRMSREVIEWTHEIRPRICES SOURCEOFSTICKINESSINTHERESPONSEOFINFLATION FOLLOWING hMAINLYv TIMEDEPENDENT RULES TOSHOCKS!SCANBESEENIN4ABLEAROUND AROUNDHALFOFTHEMFOLLOWBOTHTIMEANDSTATE HALFOFTHEFIRMSREVIEWTHEIRPRICESTAKINGINTO DEPENDENT RULES4HE SHARE OF FIRMS FOLLOWING ACCOUNTAWIDERANGEOFINFORMATIONINCLUDING MAINLYTIMEDEPENDENTRULESGENERALLYINCREASES BOTHPASTANDEXPECTEDECONOMICDEVELOPMENTS SLIGHTLYWITHTHESIZEOFTHEFIRMITISHIGHERFOR ONETHIRD OF THEM ADOPT BACKWARDLOOKING SERVICESTHANFORTRADEEXCEPTFOR"ELGIUMAND BEHAVIOUR!LARGEFRACTIONOFFIRMSABOUTONE THIRDHOWEVERISNOTFORWARDLOOKINGTAKING ONLYHISTORICDATAINTOACCOUNT$EVIATIONSFROM 4ABLE)MPORTANCEOFTIMEDEPENDENTVS STATEDEPENDENTPRICINGRULESIN FULLY OPTIMISING BEHAVIOUR ARE ALSO EVIDENT FROM THE RESULTS AVAILABLE FOR FOUR COUNTRIES WHICHINDICATETHATAhRULEOFTHUMBvSUCHAS -AINLYTIME 4IMEANDSTATE -AINLYSTATE #OUNTRY DEPENDENT DEPENDENT DEPENENT INDEXATION BASED ON THE CONSUMER PRICE INDEX "ELGIUM OR A FIXED PERCENTAGE ADAPTATION IS USED BY 'ERMANY OFFIRMSIN"ELGIUMIN3PAIN 3PAIN IN,UXEMBOURGANDIN0ORTUGAL &RANCE )TALY ,UXEMBOURG 4HE.ETHERLANDS !USTRIA 0ORTUGAL %UROAREA -OREPRECISELYACCUMULATINGPOSITIVEPRODUCTSPECIFICINFLATION INCREASESTHELIKELIHOODOFAPRICEINCREASEWHILEITMAKESPRICE REDUCTIONS LESS LIKELY NEGATIVE PRODUCTSPECIFIC INFLATION INCREASESTHELIKELIHOODOFAPRICEDECREASEWHILEITMAKESPRICE INCREASESLESSLIKELY3EEFOREXAMPLE!UCREMANNEAND$HYNE A&OUGÒREETAL$IAS2OBALO-ARQUESAND3ANTOS 3ILVA 3OURCE &ABIANI ET AL %URO AREA FIGURES HAVE BEEN ESTIMATEDUSING'$0WEIGHTS 23 4ABLE)NFORMATIONSETUSEDINPRICINGDECISIONSIN #OUNTRY 2ULEOFTHUMB 0ASTPRESENTCONTEXT 0RESENTFUTURECONTEXT 0ASTPRESENTANDFUTURE "ELGIUM 3PAIN )TALY ,UXEMBOURG !USTRIA 0ORTUGAL %UROAREA 3OURCE&ABIANIETAL%UROAREAFIGURESHAVEBEENESTIMATEDUSING'$0WEIGHTS.OTETHATTHEPRECENTAGESFORTHEEUROAREADO NOTADDUPTOASDIFFERENTANSWERCATEGORIESWEREALLOWEDFORINTHEVARIOUSCOUNTRIES &URTHERMORE ALL SURVEYS CONTAINED A QUESTION WHICH DIRECTLY ADDRESSED THE REASONS FOR PRICE STICKINESS FOR EXAMPLE h)F THERE ARE REASONS FOR CHANGING THE PRICE OF YOUR MAIN PRODUCT WHICHOFTHEFOLLOWINGFACTORSMAYWELLPREVENT AN IMMEDIATE PRICE ADJUSTMENTv 4HE LIST FOLLOWING THIS QUESTION OFFERS A SERIES OF STATEMENTSEXPRESSEDINSIMPLETERMSBASEDON DIFFERENTECONOMICTHEORIESOFPRICERIGIDITIES 4HERESPONDENTSCOULDINDICATETHEIRDEGREEOF AGREEMENTWITHEACHSTATEMENTCHOOSINGFROM AMONG FOUR CATEGORIES UNIMPORTANT OF MINOR IMPORTANCE IMPORTANT AND VERY IMPORTANT WHERE THE NUMBERS IN BRACKETS INDICATE THE SCORES ATTACHED TO EACH CATEGORY 4HEMEANSCORESATTACHEDTOTHEVARIOUSTHEORIES BYTHEFIRMSINEACHCOUNTRYHAVEBEENUSEDTO CALCULATEARANKINGOFPOSSIBLEREASONSFORPRICE STICKINESS4HERESULTSARESHOWNIN4ABLE WHICHALSOPROVIDESTHEAVERAGERANKINGFORTHE EUROAREA"ASEDONTHISRANKINGTHREEGROUPS OFTHEORIESCANBEDEFINEDTHEFIRSTCONSISTSOF THOSE THEORIES THAT HAVE AN AVERAGE SCORE WELL ABOVE TWO THE SECOND CONTAINS THOSE CLOSE TO TWO AND THE THIRD COVERS THE REMAINING ONES 5SING THIS GROUPING IMPLICIT AND EXPLICIT CONTRACTS COSTBASED PRICING AND COORDINATION FAILURE ARE THE MOST RELEVANT EXPLANATIONS FOR STICKY PRICES WHILE MENU COSTS PRICING THRESHOLDS AND COSTLY INFORMATION ARE NOT RECOGNISEDASIMPORTANTBYTHERESPONDENTS 4HE THEORY OF hIMPLICIT CONTRACTSv HAS THE HIGHEST AVERAGE SCORE AND RANKS FIRST IN FOURCOUNTRYQUESTIONNAIRES4HETHEORYISBASED ON THE IDEA THAT FIRMS ESTABLISH LONGTERM RELATIONSHIPS WITH CUSTOMERS IN ORDER TO MAKE 4HESE RESULTS ARE COMPARABLE TO THOSE OBTAINED FOR *APAN 3WEDENTHE5NITED3TATESANDTHE5NITED+INGDOM#OMPARED TOTHE5NITED3TATESONEDIFFERENCEREGARDSTHEIMPORTANCEOF CHANGESINNONPRICEFACTORSWHICHHASBEENFOUNDTOBEHIGHER INTHE5NITED3TATESTHANINTHEEUROAREA)N#ANADATHELOW RANKEDOPTIONSWERESIMILARTOTHOSEINTHEEUROAREAWHEREAS SOME DIFFERENCES EMERGE FOR THE OPTIONS THAT EMERGED AS THE MOREIMPORTANTINTHEEUROAREA.OTABLYIMPLICITCONTRACTSAND COORDINATIONFAILURERANKCONSIDERABLYLOWERIN#ANADA 4ABLE2ANKINGOFTHEORIESEXPLAININGPRICESTICKINESS "ELGIUM 'ERMANY 3PAIN &RANCE )TALY ,UXEM BOURG .ETHER LANDS !USTRIA 0ORTUGAL %URO !REA )MPLICITCONTRACTS %XPLICITCONTRACTS #OSTBASEDPRICING #OORDINATIONFAILURE *UDGINGQUALITYBYPRICE 4EMPORARYSHOCKS #HANGENONPRICEFACTORS -ENUCOSTS #OSTLYINFORMATION 0RICINGTHRESHOLDS 3OURCE&ABIANIETAL%UROAREAFIGURESAREUNWEIGHTEDAVERAGESOFCOUNTRYSCORES 24 FUTURE SALES MORE PREDICTABLE IN OTHER WORDS THEY TRY TO WIN CUSTOMER LOYALTY SIMPLY BY CHANGINGPRICESASLITTLEASPOSSIBLE#USTOMERS AREATTRACTEDBYACONSTANTPRICEBECAUSEITHELPS THEM TO MINIMISE SEARCH COSTS EG SHOPPING TIMEWITHTHERESULTTHATTHEYFOCUSONTHELONG TERMAVERAGEPRICERATHERTHANONTHESPOTPRICE 4HISISCONSISTENTWITHTHEFACTTHATMOSTOFTHE FIRMSINTHESURVEYHAVESOMESORTOFLONGTERM RELATIONSHIP WITH THEIR CUSTOMERS h%XPLICIT CONTRACTSvFIRMSHAVETORENEGOTIATEACONTRACT TO CHANGE THEIR PRICES AS AN EXPLANATION FOR STICKYPRICESISTHESECONDMOSTIMPORTANTFACTOR ATTHEEUROAREALEVELWITHANAVERAGESCOREOF 4HE SAME AVERAGE SCORE IS ATTRIBUTED TO hCOSTBASEDPRICINGvWHICHASSUMESTHATPRICES DONOTCHANGEIFCOSTSDONOTCHANGEORTHATTHEY RESPONDONLYWITHALAGTOCOSTCHANGES)NTHE CASEOFhCOORDINATIONFAILUREvWHICHEARNSAN AVERAGESCOREOFTHEIDEAISTHATFIRMSPREFER NOT TO CHANGE THEIR PRICES UNLESS ONE OF THEIR COMPETITORS MOVES FIRST )F A FIRM IS THE ONLY ONE TO INCREASE ITS PRICE AFTER A SHOCK IT MAY LOSE CUSTOMERS ON THE OTHER HAND A SINGLE HANDEDPRICEREDUCTIONMIGHTSPARKOFFAPRICE WAR WHICH COULD IN THE END BE DETRIMENTAL TO THE FIRMS PROFITS 7ITHOUT A COORDINATING MECHANISMTHATALLOWSFIRMSTOMOVETOGETHER PRICESMAYREMAINFIXED GREATERBEARINGONTHEFIRSTORTHESECONDSTAGE OF PRICE ADJUSTMENT 7ITH THE MOST RELEVANT IMPEDIMENTS BEING IMPLICIT AND EXPLICIT CONTRACTS COSTBASED PRICING AND COORDINATION FAILURE THE MAIN IMPEDIMENTS TO PRICE ADJUSTMENTSEEMTOCONCERNTHESECONDSTAGEOF PRICE SETTING IE ACTUALLY CHANGING PRICES #OSTSOFGATHERINGRELEVANTINFORMATIONWHICH SHOULD WEIGH MORE PROMINENTLY IN THE PRICE REVIEWSTAGEWEREGENERALLYNOTMENTIONEDAS IMPORTANT &INALLY THE SURVEY RESULTS SHOW ANOTHER IMPORTANT REGULARITY NAMELY AN ASYMMETRY IN PRICEADJUSTMENT4HEREISAGENERALPATTERNTHAT COSTSHOCKSAREMORERELEVANTFORPRICEINCREASES THAN FOR PRICE DECREASES WHEREAS SHOCKS TO MARKET CONDITIONS MATTER MORE WHEN PRICES HAVETOBEDECREASED/NTHECOSTSIDEITISIN PARTICULAR THE DEVELOPMENT OF LABOUR AND RAW MATERIAL COSTS WHICH MIGHT LEAD TO PRICE INCREASES WHILE FINANCIAL COSTS ARE OF MINOR IMPORTANCE CONVERSELY PRICE DECREASES ARE MAINLY AFFECTED BY WEAKENING DEMAND OR DECREASING PRICES OF COMPETITORS &IRMS IN HIGHLY COMPETITIVE MARKETS REACT PARTICULARLY STRONGLYTOPRICEDECREASINGSHOCKSESPECIALLY ONTHEDEMANDSIDE4HESEASYMMETRIESMAYBE IMPORTANT FOR THE CONDUCT OF MONETARY POLICY AS THEY CAN IMPLY IN THE SHORT TERM DIFFERENT 4HEIMPORTANCEATTACHEDTOTHEVARIOUSTHEORIES IMPACTS OF POSITIVE OR NEGATIVE SHOCKS WHICH DIFFERSONLYSLIGHTLYACROSSSECTORS)NTHEGOODS MONETARYPOLICYMIGHTWANTTOTAKEINTOACCOUNT SECTORTHERANKINGISVERYSIMILARTOTHEOVERALL INITSREACTIONTOTHESESHOCKS ONE WITH SMALL DIFFERENCES ONLY WITHIN THE GROUP OF LOWRANKED THEORIES4HIS SHOULD NOT 4O SOME EXTENT THIS ASYMMETRY COULD BE COMEASASURPRISESINCETHEGOODSSECTORISTHE VERIFIED ALSO FOR CONSUMER PRICES USING THE DOMINANT SECTOR IN NEARLY ALL COUNTRY SURVEYS MICRO PRICE RECORDS FOR 'ERMANY )T HAS BEEN 3IMILARLY IN THE SERVICES SECTOR THERE SEEM TO FOUNDTHATINPUTPRICEINFLATIONISANIMPORTANT BE ONLY MINOR DIFFERENCES WITH RESPECT TO THE DETERMINANTFORTHEFREQUENCYOFPRICEINCREASES OVERALL RANKING ,ARGER DIFFERENCES APPEAR BUT NOT FOR PRICE DECREASES 7HAT MATTERS FOR INSTEADINTHERANKINGGIVENTOTHETHEORIESBY BOTH INCREASES AND DECREASES HOWEVER IS THE FIRMSINTHETRADESECTOREXPLICITCONTRACTSARE VARIABILITY OF INPUT PRICE INFLATION THE MORE OF MINOR IMPORTANCE WHILE PRICING THRESHOLDS VOLATILE IT IS THE MORE FREQUENTLY PRICES ARE ANDMENUCOSTSRECEIVEHIGHERSCORESTHANINTHE ADJUSTED UPWARDS AND DOWNWARDS 4HESE OTHERSECTORS PATTERNS HAVE BEEN FOUND FOR THE FULL PRODUCT SAMPLE WHEREAS THE EFFECTS OF INPUT PRICE 4HE RANKING GIVEN BY FIRMS TO THE VARIOUS INFLATION DISAPPEAR STATISTICALLY FOR A CORE FACTORS BEHIND PRICE STICKINESS PROVIDES SOME MEASURE OF INFLATION IE WHEN EXCLUDING EVIDENCE AS TO WHETHER THESE FACTORS HAVE A UNPROCESSED FOOD AND ENERGY )T IS NOT CLEAR 25 &IGURE&REQUENCIESOFPRICECHANGESAND THESHAREOFRAWMATERIALINPUTSIN3PAIN &IGURE&REQUENCIESOFPRICECHANGESAND THELABOURSHAREIN3PAIN 3OURCE«LVAREZETALB 3OURCE«LVAREZETALB HOWEVER WHETHER THIS IS DUE TO A STATISTICAL PROBLEM INPUT PRICE INFLATION MOVES TOO LITTLE TO FIND STATISTICALLY SIGNIFICANT EFFECTS OR TO WHETHERTHERELATIONSHIPISINDEEDABSENTFORA BASKET THAT EXCLUDES UNPROCESSED FOOD AND ENERGY (OWEVERTHEROLEOFTHEVARIABILITYOF INPUTPRICESFORTHEFREQUENCYOFPRICECHANGES IS ALSO OBSERVED WHEN ESTIMATING STRUCTURAL MODELS OF INFLATION DYNAMICS AT THE AGGREGATE LEVEL AND FOR PRODUCER PRICES )T HAS BEEN FOUNDTHATHIGHERSHARESOFLABOURINPUTIMPLY LOWER FREQUENCIES OF PRICE CHANGES AND CONVERSELY THAT HIGHER SHARES OF RAW MATERIAL INPUTARERELATEDTOHIGHERFREQUENCIESOFPRICE CHANGES4HESEEFFECTSAREILLUSTRATEDIN&IGURES AND WHICH SHOW THE RELATIONSHIPS OBSERVED WITH THE 3PANISH DATA WHERE IT HAS BEEN FOUND THAT A INCREASE IN THE LABOUR SHAREFORAPRODUCTDECREASESTHEFREQUENCYOF PRICECHANGESBY!SWAGECOSTSAREMUCH LESS VOLATILE THAN RAW MATERIAL PRICES THESE PATTERNSSHOWACLEARRELATIONSHIPBETWEENTHE VOLATILITY OF INPUT PRICES AND THE FREQUENCY OF PRICECHANGES FIRMSTHATINCREASEPRICESGENERALLYSHOWSPEAKS INSUCHMONTHSASILLUSTRATEDIN&IGURE 4HEHYPOTHESISTHATSLUGGISHPRICEDYNAMICSARE RELATED TO LOW COMPETITIVENESS OF PRODUCT MARKETS WAS ALSO TESTED USING THE MICRO PRICE OBSERVATIONS4HEREISSUBSTANTIALEVIDENCETHAT THE FREQUENCY OF CONSUMER PRICE CHANGES DEPENDS ON THE OUTLET TYPE IT IS SIGNIFICANTLY HIGHERINSUPERMARKETSANDHYPERMARKETSTHAN IN TRADITIONAL CORNER SHOPS 4HIS CAN REFLECT EITHER DIFFERENCES IN THE DEGREE OF PRICE COMPETITION THE RELATIVE IMPORTANCE OF MENU COSTSORDIFFERENTPRICINGSTRATEGIESEVERYDAY LOW PRICING VERSUS HIGHLOW PRICING IN THOSE DIFFERENT TYPES OF STORES ,OOKING AT PRODUCER PRICESCOMPETITIVENESSOFTHEMARKETSINWHICH FIRMSOPERATEISSIMILARLYIMPORTANTTHEMORE COMPETITIVE THE ENVIRONMENT THE MORE FREQUENTLYPRICESCHANGE !NOTHERREASONFORSLUGGISHPRICEDYNAMICSIN THE RETAIL SECTOR CAN BE SEEN IN THE USE OF ATTRACTIVE PRICING WHICH IS A WIDESPREAD PRACTICEINPRICESETTINGINTHEEUROAREAnMORE 4HEIMPORTANCEOFWAGESFORPRICESETTINGHAS SOFORCONSUMERPRICESTHANFORPRODUCERPRICES ALSO BEEN ILLUSTRATED FOR THE CASE OF 'ERMANY BUT EVEN FOR THE LATTER ATTRACTIVE PRICING IS !S WAGESETTING IN 'ERMANY IS HIGHLY 3EE(OFFMANNAND+URZ+IM SYNCHRONISEDWITHTRADEUNIONSBEINGORGANISED 3EE 2UMLER WHO ESTIMATES OPEN ECONOMY .EW ON A SECTORAL BASIS IT IS POSSIBLE TO ANALYSE +EYNESIAN 0HILLIPS CURVES FOR SEVERAL EURO AREA COUNTRIES AND FINDSTHATFIRMSFACINGMOREVARIABLEINPUTCOSTSTENDTOADJUST WHETHER F IRMS CHANGE THEIR PRICES IN A THEIRPRICESMOREFREQUENTLY SYNCHRONISEDFASHIONINTHEMONTHSOFNEGOTIATED "AUDRY ET AL $IAS $IAS AND .EVES *ONKER ET AL 6ERONESEETAL WAGEINCREASES!SAMATTEROFFACTTHESHAREOF 26 Figure 4.4 Share of firms with price increases and months of negotiated wage increases in Germany Machinery Electrical machinery 40 40 40 40 30 30 30 30 20 20 20 20 10 10 10 10 0 1980 m1 0 1982 m1 1984 m1 1986 m1 1988 m1 0 1980 m1 1990 m1 0 1982 m1 1984 m1 1986 m1 1988 m1 1990 m1 Source: Stahl (2005). The chart shows the share of firms that increases prices in a given month (blue line), for the machinery industry (Upper panel) and the electrical machinery industry (lower panel). The vertical lines denote months in which wages were increased according to the union-wide wage settlements for the respective industries. observed and changes the frequency of price changes. It is generally found that prices which are set at an attractive level are changed less frequently than other prices. 43 Attractive pricing could therefore be a source of rigidity, as a retailer may (temporarily) decide not to reset its price in response to a shock because the optimal response would be an unattractive price. 44 5 This section explores the monetary policy implications of the IPN findings, focusing in particular on the fact that the degree of intrinsic inflation persistence in the euro area is limited and similar to that in the United States, whereas the degree of price level stickiness is considerable and higher than in the United States. For this analysis we make use of an estimated micro-founded DSGE model of the euro area, as the one proposed by Smets and Wouters (2003). The main reason for using such a micro-founded model is that the micro empirical findings about the degree of price stickiness can be incorporated more easily, while being detailed enough to mimic the salient features of the euro area economy. INFLATION PERSISTENCE AND PRICE STICKINESS: MONETARY POLICY IMPLICATIONS Several of the findings reported in the previous section have implications for various economic policies, for example structural policies. Structural reforms that further enhance competition in goods and, in particular, services markets at both the producer and retailer levels might be a useful step to reduce price stickiness and facilitate the adjustment of prices to economic conditions. Moreover, labour market reforms geared towards increasing the flexibility of wages and, where relevant, the abolishment of wage indexation clauses could help to reduce inflation persistence. Accordingly, the degree of inflation persistence and price stickiness might well be changing in the future, also in response, for example, to more cross-border competition in the EU or to globalisation. Section 5.1 investigates the implications for the response of a medium-term orientated monetary policy to cost-push shocks. The simulations show that high price stickiness primarily increases the persistence of output developments, whereas the persistence of inflation is not affected so much. The IPN findings are therefore consistent with the empirical observation that 43 Álvarez and Hernando 2004; Aucremanne and Dhyne 2005a; Baumgartner et al. 2005. 44 An interesting observation in this respect relates to the euro cash changeover, when euro area retailers had to convert prices from their national currency to the euro. Not unexpectedly, the frequency of price changes increased significantly in January 2002, as well as during a six-month period before and/or after the conversion to the euro. See, for example, Baudry et al. 2004; Baumgartner et al. 2005; Cornille 2003; Hoffmann and KurzKim 2005; Jonker et al. 2004. 27 OUTPUTPERSISTENCEISHIGHERINTHEEUROAREATHAN INTHE5NITED3TATESWHEREASINFLATIONPERSISTENCE ISSIMILAR&URTHERMOREALOWDEGREEOFINTRINSIC INFLATIONPERSISTENCEANDAHIGHDEGREEOFPRICE LEVELSTICKINESSAPPEARTOJUSTIFYALESSAGGRESSIVE RESPONSETOCOSTPUSHSHOCKS)NTHISRESPECTA NUMBEROFCAVEATSAREALSOMENTIONEDIN3ECTION &INALLY 3ECTION ADDRESSES SOME OTHER MONETARYPOLICYIMPLICATIONSSTEMMINGFROMTHE HETEROGENEITYINPRICESTICKINESSANDTHEPRESENCE OFDOWNWARDPRICEFLEXIBILITY )-0,)#!4)/.3&/2-/.%4!290/,)#9 4O UNDERSTAND THE IMPLICATIONS OF A MODERATE DEGREEOFINTRINSICINFLATIONPERSISTENCEANDTHE HIGHDEGREEOFPRICELEVELSTICKINESSFORMONETARY POLICYWEINVESTIGATETHERESPONSEOFAMEDIUM TERM ORIENTATED MONETARY POLICY TO COSTPUSH SHOCKS IN THE ESTIMATED EURO AREA MODEL OF 3METS AND 7OUTERS UNDER DIFFERENT DEGREES OF INTRINSIC INFLATION PERSISTENCE AND PRICESTICKINESS !MEDIUMTERMORIENTEDMONETARYPOLICYAIMS AT STABILISING INFLATION OVER THE MEDIUM TERM THEREBY AVOIDING EXCESSIVE FLUCTUATIONS IN THE OUTPUT GAP AND NOMINAL INTEREST RATES )N THE SIMULATIONEXERCISETHISISCAPTUREDBYACENTRAL BANKLOSSFUNCTIONTHATPUTSADOMINANTWEIGHT ON INFLATION STABILISATION AND A SMALL WEIGHT ON THE STABILISATION OF THE OUTPUT GAP AND INTEREST RATE CHANGES !S DISCUSSEDIN3VENSSONAND3METS THEREISACORRESPONDENCEBETWEENTHEHORIZON OFACENTRALBANKANDTHEWEIGHTONOUTPUTGAP AND INTEREST RATE STABILISATION -OREOVER IT IS ASSUMED THAT THE CENTRAL BANK ACTS UNDER COMMITMENT IE IT CAN CREDIBLY COMMIT TO FUTURESTATEDEPENDENTINTERESTRATEPATHS 4HECENTRALEQUATIONFORINFLATIONTHATCAPTURES THEDEGREEOFINTRINSICINFLATIONPERSISTENCEAND PRICE LEVEL STICKINESS IN THE 3METS7OUTERS MODELTAKESTHEFORMOFAHYBRID.EW+EYNESIAN 0HILLIPSCURVE.+0#SIMILARTOEQUATION 4HEDEGREEOFPRICESTICKINESSAFFECTSTHESLOPE OF0HILLIPSCURVEORINOTHERWORDSTHEELASTICITY OFINFLATIONWITHRESPECTTOTHEMARGINALCOST)N 28 THEBASELINEESTIMATEWEASSUMETHATTHEAVERAGE DURATIONOFPRICESISONEYEARINLINEWITHTHE MICRO EVIDENCE REPORTED ABOVE 4HIS WILL BE COMPAREDWITHLOWERAVERAGEDURATIONSOFTHREE ANDTWOQUARTERSWHICHISMOREINLINEWITHTHE MICROEVIDENCEFOUNDFORTHE5NITED3TATES 4HE 3METS7OUTERS MODEL ALSO ALLOWS FOR INTRINSICINFLATIONPERSISTENCEBYASSUMINGTHAT AFRACTIONOFPRICESETTERSAUTOMATICALLYREFERTO PAST INFLATION WHEN SETTING THEIR PRICES 4HIS INDEXATION PARAMETER IS CAPTURED BY THE COEFFICIENT OF THE LAGGED INFLATION RATE IN THE .+0#4HISIMPLIESTHATCURRENTINFLATIONWILL DEPENDNOTONLYONCURRENTANDFUTUREEXPECTED FUNDAMENTALS SUCH AS MARGINAL COSTS BUT ALSO ONLAGGEDINFLATION)NTHESIMULATIONSREPORTED BELOWWEWILLVARYTHEDEGREETOWHICHINFLATION DEPENDSONITSOWNLAGS)NTHEBASELINEESTIMATE IT IS FOUND THAT THE DEPENDENCE ON LAGGED INFLATIONISQUITESMALLINLINEWITHMOST OFTHE)0.MACROANALYSISREPORTEDABOVE4HIS IS ALSO BROADLY CONSISTENT WITH THE SURVEY EVIDENCE ON THE IMPORTANCE OF RULESOFTHUMB INPRICESETTINGWHILETHEINDEXATIONPARAMETERS WILLBEANDINTHELOWANDHIGHPERSISTENCE CASERESPECTIVELY 4WO FACTORS MOTIVATE THE FOCUS ON COSTPUSH SHOCKS &IRST THE EURO AREA HAS BEEN HIT BY A SERIES OF COSTPUSH SHOCKS OVER THE PAST FIVE YEARS DUE FOR INSTANCE TO ADVERSE WEATHER CONDITIONS ANIMAL DISEASES AND SHOCKS TO OIL PRICES)TISTHEREFOREINTERESTINGTOSEEWHATTHE )0. FINDINGS IMPLY FOR THE APPROPRIATE POLICY RESPONSE TO SUCH SHOCKS 3ECOND COSTPUSH 2ESULTS ARE GENERALLY ROBUST TO VARIATIONS IN THE LOSS FUNCTION PARAMETERS UNLESS THE WEIGHTS ON THE OUTPUT GAP AND INTEREST RATECHANGESARESETTOZERO)NTHISLATTERCASEMONETARYPOLICY WILLATTEMPTTOCOUNTERACTMOVEMENTSININFLATIONIMMEDIATELY ANDFULLYTHUSCREATINGANUNREASONABLEAMOUNTOFINTERESTRATE AND OUTPUT GAP VOLATILITY AS A CONSEQUENCE MONETARY POLICY WOULDBEMOREAGGRESSIVEINANECONOMYWITHSTICKIERPRICES 4HEREPORTEDRESULTSARECONFIRMEDINAROBUSTNESSCHECKWHICH CONSIDERSTHECASEINWHICHMONETARYPOLICYSEEKSTOMINIMIZE A MODELCONSISTENT LOSS FUNCTION PROPERLY DERIVED FROM THE UTILITYOFTHEREPRESENTATIVECONSUMERASDISCUSSEDIN!LTISSIMO #URDIAAND2ODRIGUEZ0ALENZUELA&INALLYTHERESULTSALSO APPEARROBUSTTOSIMPLERVARIANTSOFTHE.EW+EYNESIANMODEL USED )NTHE3METS7OUTERSMODELTHESEVARIOUSSOURCESOFCOSTPUSH SHOCKSARENOTEXPLICITLYMODELLEDBUTARECAPTUREDINTHEERROR TERMTOTHE.EW+EYNESIAN0HILLIPSCURVE &IGURE)NTRINSICINFLATIONPERSISTENCEANDTHEPOLICYRESPONSETOCOSTPUSHSHOCKS .OTES)MPULSERESPONSESTOAONESTANDARDDEVIATIONCOSTPUSHSHOCKINTHE3METS7OUTERSMODELFORLOWMEDIUMAND HIGHLEVELSOFTHEINDEXATIONPARAMETERUNDERAMEDIUMTERMORIENTATEDMONETARYPOLICY SHOCKSGENERALLYPUTTHECENTRALBANKBEFOREA SHOCKS BOTH IN TERMS OF THE SIZE AND THE DILEMMA AS THEY TEND TO CHANGE PRICES AND PERSISTENCE OF THE RESPONSE 4HE REASONS ARE OUTPUTINDIFFERENTDIRECTIONS QUITESTRAIGHTFORWARD&IRSTWITHALOWERDEGREE OF INFLATION PERSISTENCE THE IMMEDIATE IMPACT &IGURES AND RESPECTIVELY PLOT THE OFANINFLATIONSHOCKWILLBESMALLERASAGENTS RESPONSESOFOUTPUTINFLATIONANDTHENOMINAL ANTICIPATE A LOWER PERSISTENCE OF THIS INFLATION AND REAL POLICY RATE TO A COSTPUSH SHOCK IN SHOCK AND THEREFORE REDUCE THEIR EXPECTATIONS PRESENCEOFDIFFERENTDEGREEOFINTRINSICINFLATION OF FUTURE INFLATION 4HIS HAS AN IMMEDIATE PERSISTENCE AND DIFFERENT PRICE STICKINESS DAMPENINGEFFECTONCURRENTINFLATION3ECOND &IGURE SHOWS THAT A SMALLER DEGREE OF ASTHERESPONSEOFINFLATIONISLOWERTHENEGATIVE INTRINSIC INFLATION PERSISTENCE IMPLIES A MUCH RESPONSE OF THE OUTPUT GAP WILL ALSO BE LOWER SMALLER RESPONSE OF POLICY RATES TO COSTPUSH &INALLYASTHERESPONSEOFINFLATIONISMUCHLESS 29 &IGURE0RICESTICKINESSANDTHEPOLICYRESPONSETOCOSTPUSHSHOCKS .OTES )MPULSE RESPONSES TO A ONESTANDARD DEVIATION COSTPUSH SHOCK IN THE 3METS7OUTERS MODEL FOR LOW TWO QUARTERS MEDIUM THREEQUARTERSANDHIGHFOURQUARTERSLEVELSOFTHEAVERAGEDURATIONOFPRICESUNDERAMEDIUMTERMORIENTATEDMONETARYPOLICY.OTE ALSO THAT IN THIS FIGURE THE BASELINE CASE THAT CORRESPONDS TO THE MEDIUMPERSISTENCE CASE WHILE IN &IGURE IS THE HIGHSTICKINESS CASE PERSISTENT THE RESPONSE OF THE REAL RATE WILL HAVETOBEMUCHLESSPERSISTENT)NOTHERWORDS THE BENEFIT OF A LOW DEGREE OF INFLATION PERSISTENCE IS AN IMPROVED INFLATIONOUTPUT VARIABILITY TRADEOFF AND A MUCH REDUCED NEED TORESPONDTOCOSTPUSHSHOCKS &IGURE ILLUSTRATES THE IMPACT OF THE DEGREE OF PRICE STICKINESS ON THE RESPONSE OF OUTPUT INFLATIONANDTHENOMINALANDREALPOLICYRATE !FIRSTTHINGTONOTEISTHATAHIGHERDEGREEOF 30 PRICELEVELSTICKINESSLEADSTOAMOREPERSISTENT OUTPUTRESPONSEWHEREASTHEEFFECTONTHESHAPE ANDTHEMAGNITUDEOFTHEINFLATIONRESPONSEIS RELATIVELY MINOR 4HIS COULD PROVIDE ONE EXPLANATION OF THE n AT FIRST SIGHT n PUZZLING EVIDENCEPRESENTEDABOVETHATWHILEPRICELEVEL STICKINESSISHIGHERINTHEEUROAREATHANINTHE 5NITED 3TATES REDUCEDFORM ESTIMATES OF INFLATIONPERSISTENCEARESIMILARINBOTHREGIONS (IGHERPRICELEVELSTICKINESSDOESNOTNECESSARILY LEAD TO MUCH HIGHER INFLATION PERSISTENCE "Y CONTRAST IT DOES LEAD TO A HIGHER DEGREE OF TO A SLOWER ECONOMIC ADJUSTMENT PROCESS IN OUTPUTPERSISTENCE RESPONSE TO OTHER SHOCKS SUCH AS CHANGES IN PRODUCTIVITY WHICH WILL TEND TO BE COSTLY 5NDERTHEOPTIMALMONETARYPOLICYCONSIDERED 3ECONDAHIGHERDEGREEOFPRICESTICKINESSWILL HERETHEPATHFORINFLATIONDOESNOTDEPENDVERY INCREASE THE COSTS OF INFLATION 4HE REASON IS MUCHONTHEDEGREEOFPRICESTICKINESS(OWEVER INTUITIVE AS FEWER PRICES ARE ADJUSTED HIGHER AHIGHERDEGREEOFPRICESTICKINESSIMPLIESTHAT INFLATIONWILLTENDTOLEADTOBIGGERINEFFICIENT THEOVERALLSACRIFICERATIOINVOLVEDINACHIEVING RELATIVE PRICE CHANGES /NE IMPORTANT THIS BROADLY SIMILAR INFLATION PATH IS HIGHER IMPLICATIONOFTHISISTHATHIGHERPRICESTICKINESS 4HIS CAN BE SEEN BY NOTING THAT FOR SIMILAR STRENGTHENS THE CASE FOR FOCUSING ON PRICE PROFILESOFINFLATIONTHECUMULATIVEOUTPUTLOSS STABILITY)FASARESULTTHECENTRALBANKSHORTENS ISHIGHESTFORTHESTICKIERECONOMY(OWEVERA ITSHORIZONFORMAINTAININGPRICESTABILITYTHIS HIGHERDEGREEOFPRICESTICKINESSALSOIMPLIESA MAY COUNTERBALANCE THE FINDING MENTIONED LESSAGGRESSIVEMONETARYPOLICYREACTIONINTHE ABOVETHATHIGHERPRICESTICKINESSLEADSTOLESS SENSE OF SMALLER AND FEWER CHANGES IN THE AGGRESSIVERESPONSESTOCOSTPUSHSHOCKS)NAN NOMINAL POLICYCONTROLLED INTEREST RATE 4HE EXTREME CASE UNDER THE ASSUMPTION THAT THE MAIN REASON FOR THIS IS TWOFOLD 7ITH HIGHER CENTRAL BANK DOES NOT PUT ANY WEIGHT ON THE PRICESTICKINESSAGIVENCHANGEINTHENOMINAL STABILISATIONOFTHEOUTPUTGAPANDINTERESTRATE INTERESTRATEWILLHAVEALARGEREFFECTONTHEREAL CHANGESUNLIKEFOREXAMPLEUNDERAMEDIUM RATE AND CONSEQUENTLY ON OUTPUT )N ADDITION TERM ORIENTATION IT WOULD REACT MORE RATHER WITH HIGHER PRICE STICKINESS A CREDIBLE CENTRAL THANLESSAGGRESSIVELYTOCOSTPUSHSHOCKS BANK HAS A GREATER INCENTIVE TO SMOOTH OUT ITS POLICYRESPONSE4HISRESULTSINASMALLERINITIAL 3/-%#!6%!43 BUT MORE PROLONGED AND PERSISTENT OUTPUT GAP )NTHISSECTIONWEDISCUSSANUMBEROFCAVEATS RESPONSE RELATEDTOTHEDISCUSSIONINTHESECTIONABOVE /VERALL A LOW DEGREE OF INTRINSIC INFLATION PERSISTENCEANDAHIGHDEGREEOFPRICESTICKINESS 5.#%24!).49!"/544(%$%'2%%/&).&,!4)/. THEREFORE APPEAR TO JUSTIFY A LESS AGGRESSIVE 0%23)34%.#%!.$02)#%,%6%,34)#+).%33 &ROM 4ABLE IT IS CLEAR THAT THERE IS A INTERESTRATERESPONSETOCOSTPUSHSHOCKS CONSIDERABLE DEGREE OF UNCERTAINTY ABOUT THE !TTHISPOINTITISWORTHMENTIONINGTWOOPPOSING ESTIMATED DEGREE OF INFLATION PERSISTENCE FACTORS THAT MAY MODIFY THE ABOVEMENTIONED 3IMILARLY MACROECONOMIC ESTIMATES OF THE CONCLUSIONS &IRST IN &IGURES AND WE DEGREE OF PRICE LEVEL STICKINESS VARY QUITE ASSUMED THAT THE SIZE OF THE COSTPUSH SHOCK CONSIDERABLY)NTHISSECTIONWEDISCUSSSOMEOF WAS NOT AFFECTED BY THE ALTERNATIVE DEGREES OF THEIMPLICATIONSOFTHISUNCERTAINTY INTRINSIC INFLATION PERSISTENCE AND PRICE STICKINESS )N THEORY AND PROBABLY ALSO IN 5NCERTAINTY ABOUT THE SLOPE OF THE 0HILLIPS PRACTICETHEEFFECTOFAGIVENCOSTPUSHSHOCK CURVE CREATES UNCERTAINTY ABOUT THE EFFECTS OF ON THE GENERAL PRICE LEVEL WILL BE LESS WHEN A MONETARY POLICY "RAINARDS CLASSICAL LARGE SHARE OF PRICES ARE STICKY IN PARTICULAR ANALYSISOFMULTIPLIERUNCERTAINTYWOULDSUGGEST PRICES IN THE SECTOR AFFECTED BY THE COSTPUSH SHOCK4HISWILLTENDTOREINFORCETHERESULTTHAT 4HE SAME PATTERN ALSO HOLDS IN AN ANALYSIS OF THE RESPONSE OF INFLATIONANDOUTPUTTOOTHERSHOCKSSUCHASASHIFTINMONETARY AHIGHERDEGREEOFPRICESTICKINESSREDUCESTHE POLICY EFFECTS OF COSTPUSH SHOCKS ON INFLATION AND &OR EXAMPLE OVER THE PERIOD THE AUTOREGRESSIVE ECONOMICACTIVITY/FCOURSEWHILETHISWORKS COEFFICIENTINAN!2ESTIMATIONFORCONSUMERPRICEINFLATION WAS IN THE EURO AREA AND IN THE 5NITED 3TATES "Y TOTHEBENEFITOFTHECENTRALBANKINTHECASEOF CONTRAST THE ANALOGOUS COEFFICIENT FOR REAL '$0 GROWTH WAS COSTPUSHSHOCKSITSHOULDBERECOGNISEDTHATA MUCH HIGHER IN THE EURO AREA THAN IN THE 5NITED 3TATES VERSUS HIGHERDEGREEOFPRICESTICKINESSWILLALSOLEAD 31 THAT THE CENTRAL BANK NEEDS TO RESPOND MORE GRADUALLY IN THE FACE OF SUCH UNCERTAINTY STRENGTHENING THE CASE FOR A LESS AGGRESSIVE MONETARYPOLICY)NDEEDWHENTHECENTRALBANK HASONLYLIMITEDKNOWLEDGEABOUTTHEEFFECTSOF ITSPOLICYITMAYWANTTOMOVECAUTIOUSLYSOAS TO AVOID UNNECESSARY FLUCTUATIONS IN THE ECONOMY!SIMILARPOLICYPRESCRIPTIONCALLING FORAMORECAUTIOUSRESPONSEALSOFOLLOWSINTHE PRESENCE OF UNCERTAINTY ON THE STATE AND EXACT CYCLICAL POSITION OF THE ECONOMY AS THE ONE ARISINGFROMTHEUNCERTAINTYONTHESIZEOFTHE OUTPUTGAPINREALTIME-ORERECENTCONTRIBUTIONS HAVE HOWEVER HIGHLIGHTED THE FACT THAT THIS POLICYADVICEISNOTUNIVERSAL4HEYSHOWTHATA MORE AGGRESSIVE POLICY RESPONSE MAY BE APPROPRIATE WHEN UNCERTAINTY IS RELATED TO THE PERSISTENCEOFTHEINFLATIONPROCESS 2ECENTLITERATUREONTHISTOPICHASOFTENFOCUSED ON THE ROBUSTNESS OF POLICIES IN FACE OF UNCERTAINTY ON THE MODEL OF THE ECONOMY MONETARYPOLICYSHOULDBEDESIGNEDSOTHATITS STABILISATION PROPERTIES REMAIN RELATIVELY GOOD IRRESPECTIVEOFTHETRUEMODELOFTHEECONOMY (EREAGAINTHEMAINFINDINGISTHATAMEDIUM TERMORIENTATEDPOLICYMAKERISWELLADVISEDTO SETPOLICYBASEDONTHEASSUMPTIONOFARELATIVELY HIGH DEGREE OF INTRINSIC INFLATION PERSISTENCE ANDPRICELEVELSTICKINESSIEARELATIVELYRIGID ECONOMY 4HE INTUITION IS SIMPLE IF THE TRUE DEGREE OF PERSISTENCE AND RIGIDITY IN THE ECONOMY IS LOW BUT THE POLICYMAKER WRONGLY ASSUMES THE CONVERSE THE POLICYMAKER WILL REACTTOOSTRONGLYTOSHOCKSIMPLYINGAWELFARE COST4HISCOSTWILLBEMODERATEASTHEECONOMY ISRELATIVELYFLEXIBLEANDTHEPOLICYMAKERCAN EASILY UNDO THE MISTAKE (OWEVER IF THE PERSISTENCEOFINFLATIONISHIGHBUTTHEPOLICY MAKERWRONGLYASSUMESTHATITISLOWTHEWEAK RESPONSEOFINTERESTRATESWILLALLOWTHEINITIAL SHOCK TO BE FACTORED INTO THE EXPECTATIONS OF AGENTSANDWILLLEADINFLATIONTODRIFTAWAY4HIS WILLENTAILAMUCHHIGHERWELFARECOSTBECAUSE IT WILL BE LESS EASY TO UNDO THE MISTAKE IN THE RELATIVELYMORERIGIDECONOMY4OINSUREAGAINST THISRISKTHEPOLICYMAKERISBETTEROFFASSUMING A RELATIVELY HIGH DEGREE OF INFLATION INERTIA /VERALLTHISARGUMENTINSERTSSOMECAUTIONIN 32 THE ABOVEMENTIONED CONCLUSION THAT LOWER INFLATION PERSISTENCE ALLOWS FOR A MORE TIMID RESPONSETOCOSTPUSHSHOCKS 4(%%.$/'%.%)49/&).&,!4)/.0%23)34%.#% !.$02)#%34)#+).%33 )NTHEANALYSISOF3ECTIONABOVETHEDEGREE OFINTRINSICINFLATIONPERSISTENCEANDPRICELEVEL STICKINESS WAS TREATED AS EXOGENOUS TO THE MONETARYPOLICYREGIME)TISINDEEDVERYLIKELY THATNEITHEROFTHOSEFEATURESAREINDEPENDENTOF THEREGIME&OREXAMPLEITHASBEENARGUEDTHAT THE APPARENT FALL IN THE DEGREE OF INFLATION PERSISTENCE OVER THE PAST DECADE IN MANY COUNTRIESINCLUDINGTHEEUROAREAHASBEENTHE RESULT OF A BETTER ANCHORING OF THE PRIVATE SECTORS INFLATION EXPECTATIONS TO THE CENTRAL BANKSPRICESTABILITYOBJECTIVE(ENCEESTIMATES OFINFLATIONPERSISTENCEARETYPICALLYSMALLERFOR SAMPLE PERIODS WHERE THE MEAN OF INFLATION IS STABLE THAN FOR SAMPLE PERIODS INCLUDING EPISODES OF TRANSITION FROM HIGH INFLATION REGIMESTOLOWINFLATIONONES 2ECENTANALYSIS HAS SHOWN THAT IF ECONOMIC AGENTS HAVE IMPERFECT KNOWLEDGE OF THE STRUCTURE OF THE ECONOMYANDTHEEXPECTATIONFORMATIONONTHE PARTOFTHEPRIVATESECTORISBASEDONSOMEFORM OF LEARNING MECHANISM THERE IS A CLEAR RELATIONSHIP BETWEEN THE MONETARY POLICY REGIME AND THE EX POST INFLATION PERSISTENCE )N PARTICULAR IT HAS BEEN FOUND THAT POLICY SHOULD RESPOND MORE AGGRESSIVELY TO INFLATION UNDERIMPERFECTKNOWLEDGEINORDERTOPROPERLY STEER THE LEARNING MECHANISM OF THE PRIVATE AGENTS /NE OF THE BENEFITS OF ASSIGNING A GREATER WEIGHT TO PRICE STABILITY IS A REDUCTION ININFLATIONPERSISTENCE 4HEPOLICYIMPLICATIONSOFTHEIMPORTANTROLEOF EXPECTATIONSFORMATIONASADETERMINANTOFTHE DEGREE OF INFLATION PERSISTENCE ARE STRAIGHTFORWARD )N ORDER TO BENEFIT FROM REDUCEDINFLATIONPERSISTENCETHECENTRALBANK &OREXAMPLE#RAINEAND3ÚDERSTRÚM 3EE,EVINAND-OESSNERANDTHEREFERENCESTHEREIN%#" CONTRIBUTIONSONTHISTOPICINCLUDE!NGELONI#OENENAND3METS #OENENAND-OESSNER 3EE#ORVOISIERAND-OJON 3EE /RPHANIDES AND 7ILLIAMS AND 'ASPAR 3METS AND 6ESTIN NEEDS TO KEEP INFLATION EXPECTATIONS ANCHORED TO THE INFLATION OBJECTIVE!S DISCUSSED ABOVE THIS WILL ALLOW THE CENTRAL BANK TO TAKE A MEDIUMTERM ORIENTATION AND SEE THROUGH THE TEMPORARYEFFECTSOFVARIOUSCOSTPUSHSHOCKS /N THE OTHER HAND WHEN A SERIES OF COSTPUSH SHOCKS IN ONE DIRECTION RISKS INCREASING THE PERCEIVED DEGREE OF PERSISTENCE BY THE PRIVATE SECTORINFLATIONEXPECTATIONSANDINFLATIONITSELF COULDBECOMEUNANCHOREDANDCOSTLYTOCONTROL )F COMMUNICATION BY THE CENTRAL BANK CANNOT ALLEVIATETHISPROBLEMITISADVISABLETORESPOND QUITE AGGRESSIVELY AND PERSISTENTLY TO SUCH SHOCKS!NIMPORTANTINSIGHTFROMTHEREALISATION THAT THE DEGREE OF INFLATION PERSISTENCE IS ENDOGENOUSISTHATTHEPOLICYRESPONSEBECOMES DEPENDENT ON HOW WELL INFLATION AND INFLATION EXPECTATIONSAREANCHORED 3IMILARLY IT IS LIKELY THAT THE DEGREE OF PRICE LEVELSTICKINESSDEPENDSONTHEMONETARYPOLICY REGIME4HE)0.FINDINGSINDEEDCONFIRMTHAT SECTORSWITHAHIGHERSECTORALINFLATIONRATEAND HIGHER INFLATION VARIABILITY TYPICALLY EXHIBIT &IGURE7AGESTICKINESSANDTHEPOLICYRESPONSETOCOSTPUSHSHOCKS .OTES )MPULSE RESPONSES TO A ONESTANDARD DEVIATION COSTPUSH SHOCK IN THE 3METS7OUTERS MODEL FOR LOW TWO QUARTERS MEDIUM THREEQUARTERSANDHIGHFOURQUARTERSAVERAGELENGTHOFWAGECONTRACTSUNDERAMEDIUMTERMORIENTATEDMONETARYPOLICY 33 MORE FREQUENT PRICE CHANGES AS THE COSTS OF KEEPINGPRICESUNCHANGEDOUTWEIGHMENUCOSTS ANDOTHERCOSTSOFCHANGINGPRICES!STABILITY ORIENTEDMONETARYPOLICYREGIMECOULDTHEREFORE BEONEEXPLANATIONFORARELATIVELYHIGHDEGREE OF PRICE STICKINESS 4HIS ENDOGENEITY OF THE DEGREE OF PRICE STICKINESS AGAIN RAISES THE QUESTIONASTOWHATEXTENTTHEPOLICYADVICEOF ALESSAGGRESSIVERESPONSETOCOSTPUSHSHOCKS MAYITSELFAFFECTTHEDEGREEOFPRICESTICKINESS 7!'%!.$02)#%34)#+).%33 )NTHEABOVEANALYSISWEHAVEASSUMEDTHATTHE LOWERFREQUENCYOFPRICEADJUSTMENTISASSOCIATED WITHAHIGHERDEGREEOFRIGIDITYINTHESETTINGOF NOMINAL PRICES 4HIS HYPOTHESIS IS CONSISTENT WITH SOME OF THE STRUCTURAL MACRO FINDINGS REPORTED ABOVE AND WITH THE FINDING OF HIGHER OUTPUT PERSISTENCE IN THE EURO AREA (OWEVER OTHER EXPLANATIONS ARE POSSIBLE )N PARTICULAR THEREISACERTAINAMOUNTOFEVIDENCESUGGESTING THAT PRICE STICKINESS MAY BE RELATED TO WAGE STICKINESS!S MENTIONED IN 3ECTION SECTORS WITHAHIGHLABOURSHARETYPICALLYCHANGETHEIR PRICESLESSOFTENTHANOTHERSECTORS'IVENTHAT WAGESAREMORERIGIDINTHEEUROAREATHANINTHE 5NITED 3TATES THIS IS A PLAUSIBLE ALTERNATIVE EXPLANATION OF THE LOWER FREQUENCIES OF PRICE ADJUSTMENTINTHEEUROAREA ! FULL INVESTIGATION OF THE POLICY IMPLICATIONS OFWAGESTICKINESSFALLSBEYONDTHESCOPEOFTHIS NOTEBUTITMAYBEINFORMATIVETODOASIMILAR SIMULATIONEXERCISEASIN&IGURESANDFOR DIFFERENT DEGREES OF WAGE STICKINESS )N THE 3METS7OUTERSMODELTHEAVERAGEDURATIONOF WAGECONTRACTSINTHEEUROAREAISESTIMATEDTO BE ABOUT ONE YEAR WHICH IS SIMILAR TO THE AVERAGE DURATION OF PRICES )N ANALOGY WITH &IGUREABOVE&IGURESHOWSTHEIMPACT OFLOWERINGTHEAVERAGEWAGECONTRACTLENGTHTO THREE AND TWO QUARTERS RESPECTIVELY ON THE RESPONSE OF THE OUTPUT GAP INFLATION AND THE POLICY RATE TO A COSTPUSH SHOCK #OMPARING WITH &IGURE IT IS CLEAR THAT THE RESULTS ARE VERYSIMILAR(IGHERWAGESTICKINESSLEADSTOA LESS AGGRESSIVE POLICY RESPONSE TO COSTPUSH SHOCKS /NE APPARENT DIFFERENCE IS THAT THE 34 IMPACTOFWAGESTICKINESSONTHEPERSISTENCEOF THEOUTPUTGAPRESPONSEISLESSPRONOUNCED /4(%2)-0,)#!4)/.3&/2-/.%4!29 0/,)#9 )N THIS SECTION WE BRIEFLY DISCUSS THE POLICY IMPLICATIONS OF TWO OTHER )0. FINDINGS THE HETEROGENEITYINPRICESTICKINESSACROSSSECTORS AND THE FINDING THAT OVERALL ONE CAN OBSERVE MANYPRICEFALLS (%4%2/'%.%)49).02)#%34)#+).%33 !NOTHERROBUSTFINDINGCOMINGFROMTHEMICRO EVIDENCE IS THE CONSIDERABLE DEGREE OF HETEROGENEITY ACROSS SECTORS IN THE DEGREE OF PRICESTICKINESSWITHENERGYANDNONPROCESSED FOOD BEING QUITE FLEXIBLE SECTORS WHILE THE PRICES OF SERVICES AND NONENERGY INDUSTRIAL GOODS ARE CONSIDERABLY STICKIER !GAIN THE SOURCESOFTHISHETEROGENEITYWILLBEIMPORTANT FORDRAWINGPOLICYIMPLICATIONS3ECTIONHAS SUMMARISED THE AVAILABLE EVIDENCE ON THE POSSIBLE REASONS FOR SLUGGISH PRICE DYNAMICS /NEIMPORTANTRESULTWHICHHASBEENFOUNDAT BOTH THE PRODUCER AND RETAILER LEVELS IS THAT LARGERCOMPETITIONREDUCESPRICESTICKINESS&OR THE CONSUMER PRICES IT HAS BEEN FOUND THAT PRICESARECHANGEDMOREOFTENINSUPERMARKETS ANDHYPERMARKETSTHANINHIGHERPRICEDCORNER SHOPS4HISPATTERNMIGHTALSOEXPLAINPARTSOF THELARGEDIFFERENCEINPRICINGPATTERNSWITHTHE 5NITED 3TATES 7ITH A MORE COMPETITIVE RETAIL SECTORTHEFREQUENCYOFPRICEADJUSTMENTSCAN BE EXPECTED TO BE CONSIDERABLY LARGER &OR PRODUCERPRICESTHESURVEYRESULTSHAVESHOWN THATFIRMSINHIGHLYCOMPETITIVEMARKETSRESPOND MORESTRONGLYTOCHANGESINUNDERLYINGFACTORS WITHTHEDIFFERENCESBEINGMOSTPRONOUNCEDIN THECASEOFPRICEDECREASINGSHOCKSESPECIALLY 5NFORTUNATELY THERE IS VERY LITTLE DATA AVAILABLE THAT ALLOWS DIRECT COMPARISONS BETWEEN THE COMPETITIVENESS OF THE RETAIL SECTORACROSSTHEEUROAREAANDTHE5NITED3TATESFURTHERMORE THESCANTDATAISRELATIVELYOUTOFDATE0ILATSHOWSDATA ON THE NUMBER OF RETAIL OUTLETS PER INHABITANTS AND THE RETAILSALESPEREMPLOYEEBOTHFORFORTHE5NITED3TATES AND ALL EURO AREA COUNTRIES )T IS APPARENT THAT THERE WERE FAR FEWEROUTLETSINTHE5NITED3TATESPOINTINGTOAMORECONCENTRATED MARKET AND THAT RETAIL SALES PER EMPLOYEE WERE CONSIDERABLY HIGHERINTHE5NITED3TATESPOINTINGTOAMOREEFFICIENTRETAIL SECTOR3EEALSO'ORDON ONTHEDEMANDSIDEWHICHWOULDALSOSUGGEST THAT HIGH COMPETITIVENESS IN PRODUCT MARKETS LEADS TO LOWER PRICE RIGIDITIES 3TRUCTURAL REFORMSTOENHANCECOMPETITIVENESSINPRODUCT MARKETSATBOTHTHEPRODUCERANDRETAILERLEVELS ANDEXPOSINGTHESERVICESSECTORTOMORETRADE MIGHT THEREFORE BE A USEFUL STEP TOWARDS REDUCING THE IMPORTANCE OF PRICE RIGIDITIES (OWEVERITISALSOIMPORTANTTONOTETHATPRICE RIGIDITIES AS SUCH NEED NOT NECESSARILY BE UNDESIRABLE)TCOULDBEIMAGINEDTHATCONSUMERS PREFERTOPURCHASETHEIRGOODSINRETAILOUTLETS THAT CHANGE PRICES LESS FREQUENTLY )F PRICES REMAINUNCHANGEDATAVERYLOWLEVELANhALL TIMELOWv PRICING STRATEGY EXPLICITLY ADOPTED ANDMARKETEDBYSOMERETAILCHAINSTHISCANBE BENEFICIALTOCONSUMERS RELATIVEPRICESFOLLOWINGSHOCKSANDTHEOTHER MOREFLEXIBLEAMONETARYPOLICYTHATDOESNOT TAKE ACCOUNT OF SECTORAL HETEROGENEITY IN THE WEIGHTINGOFTHEPRICEINDEXIMPLIESTHATUPON THEOCCURRENCEOFANAGGREGATESHOCKTHETWO SECTORSHAVETOADJUSTINASIMILARWAY(OWEVER THE RIGID SECTOR BEARS A HIGHER COST THAN THE FLEXIBLE SECTOR IN ITS ADJUSTMENT TO THAT MACROECONOMICSHOCK4HISIMBALANCELEADSTO AWELFARELOSSFORTHECURRENCYUNIONTHATCOULD BEAVOIDED"YWEIGHTINGTHEMORERIGIDSECTOR TO TAKE ACCOUNT OF MORE THAN JUST ITS OVERALL SIZEMONETARYPOLICYWOULDTHUSMAKESURETHAT THEFLEXIBLESECTORRESPONDEDTOAHIGHERDEGREE TOTHESHOCKTHUSMAKINGASTRONGERCONTRIBUTION TO THE OVERALL ADJUSTMENT NEEDED IN THE ECONOMY 4HEEVIDENCEIN3ECTIONALSOSUGGESTSTHAT THEVARIABILITYOFINPUTCOSTSMAYALSOPLAYAN IMPORTANT ROLE IN DETERMINING DIFFERENCES IN PRICESTICKINESS&OREXAMPLEITHASBEENFOUND THATTHEFREQUENCYOFPRICECHANGESFORPRODUCER PRICESDEPENDSNEGATIVELYONTHESHAREOFLABOUR INAFIRMSINPUT4HISSUGGESTSTHATPERSISTENCE IN WAGE DEVELOPMENTS CAN BE A CAUSE OF PRICE RIGIDITIES 4HE IMPORTANCE OF LABOUR MARKET RIGIDITIESFORINFLATIONPERSISTENCEISFURTHERMORE CORROBORATED BY SIMULATIONS USING THE VARIOUS STRUCTURALMACROECONOMICMODELSFORTHEEURO AREAANDITSMEMBERCOUNTRIESTHATAREUSEDIN THE %UROSYSTEM )N THESE MODELS INFLATION PERSISTENCE IS TO A LARGE PART DRIVEN BY LABOUR MARKETS !PPLYINGTHESEIDEASTOTHECONTEXTOFTHE%#" THE )0. RESULTS WOULD POINT TO GIVING MORE PROMINENCE TO A MEASURE OF ()#0 INFLATION EXCLUDING ENERGY AND UNPROCESSED FOOD GIVEN THE LARGE DIFFERENCES IN PRICE RIGIDITIES ACROSS ENERGY AND UNPROCESSED FOOD ON THE ONE HAND ANDALLOTHERSECTORSONTHEOTHER4HEMEDIUM TERMORIENTATIONOFTHE%#"SMONETARYPOLICY STRATEGY ALLOWS FOR LOOKING THROUGH THE SHORT TERMEFFECTSOFCHANGESINFLEXIBLEENERGYAND FOOD PRICES AND CONCENTRATING ON THE MORE PERSISTENTCOMPONENTSOFTHE()#0WITHOUTTHE NEEDTOCHANGETHEINDEXUSEDINTHEDEFINITION OFPRICESTABILITY5SINGAMODIFIED()#0INDEX AS THE UNDERLYING MEASURE FOR THE %#"S DEFINITIONOFPRICESTABILITYWOULDHAVESEVERAL DRAWBACKS&IRSTOFALLEXCLUDINGSOMESECTORS BUT NOT OTHERS WOULD INTRODUCE SOME ELEMENT OFARBITRARINESSANDUNCERTAINTYINTHECONDUCT OFMONETARYPOLICYANDCOULDNEGATIVELYAFFECT THETRANSPARENCYOFTHEOBJECTIVEPURSUEDBYTHE CENTRAL BANK 3ECONDLY THE POSSIBILITY CANNOT BERULEDOUTTHATBYASSIGNINGHIGHERIMPORTANCE TO A PARTICULAR SECTORSPECIFIC DEVELOPMENT MONETARY POLICY WOULD IN PRACTICE BE ACCOMMODATING BEHAVIOURAL OR STRUCTURAL INEFFICIENCIES ULTIMATELY CREATING PERVERSE INCENTIVESANDHAMPERINGTHENECESSARYPROGRESS 2ECENTCONTRIBUTIONSTOTHEECONOMICLITERATURE HAVE HIGHLIGHTED THAT HETEROGENEITY IN THE DEGREEOFPRICESTICKINESSACROSSSECTORSANDOR COUNTRIESMAYHAVEIMPLICATIONSFORWHICHPRICE INDEX TO TARGET )N PARTICULAR ACCORDING TO THESEARGUMENTSTHECENTRALBANKSHOULDTARGET A PRICE INDEX THAT ASSIGNS A RELATIVELY LARGER WEIGHTTOTHOSESECTORSORREGIONSWHEREPRICE DEVELOPMENTSARESTICKIER 4HE RATIONALE FOR THIS CAN BE DESCRIBED AS FOLLOWS )N AN ECONOMY WITH TWO SECTORS OF EQUAL SIZES ONE MORE RIGID IE FEATURING A HIGHER DEGREE OF FRICTION IN THE ADJUSTMENT OF 35 "ERBENETAL 3EE "ENIGNO !OKI OR 'OODFRIEND AND +ING TOWARDS MORE MARKETBASED ADJUSTMENT MECHANISMS &URTHERMORE IN COMMUNICATING MONETARY POLICY IT WOULD BE A CHALLENGE TO EXPLAIN WHY PRICE DEVELOPMENTS FELT BY CONSUMERS DID NOT NECESSARILY COINCIDE WITH THOSEADDRESSEDBYTHECENTRALBANK 2EGARDLESS OF THESE CONSIDERATIONS TWO IMPORTANTGENERALCONCLUSIONSFOLLOWFROMTHE EXISTENCE OF HETEROGENEOUS PATTERNS OF PRICE RIGIDITIES&IRSTITIMPLIESTHATWHENMONITORING PRICE DEVELOPMENTS IN ORDER TO FORECAST FUTURE INFLATIONITISIMPORTANTFORTHECENTRALBANKTO ANALYSE THE SECTORAL SOURCES OF THESE PRICE MOVEMENTS 'IVEN THE DIFFERENT DEGREE OF STICKINESS UNDERSTANDING THE SOURCE OF THE SHOCKS WILL ALLOW THE CENTRAL BANK TO BETTER ASSESS THE PERSISTENCE OF THOSE DEVELOPMENTS ANDTHEREBYIMPROVEITSFORECAST3ECONDLYAND RELATEDTOTHEPREVIOUSPOINTUNDERSTANDINGTHE SECTORAL SOURCE OF INFLATION DEVELOPMENTS IS ALSO IMPORTANT FOR THE APPROPRIATE POLICY RESPONSETOINFLATIONSHOCKS7HENTHEINFLATION SHOCKSORIGINATEFROMARELATIVELYFLEXIBLESECTOR SUCH AS THE ENERGY OR FOOD SECTOR AND ARE NOT OVERLY PERSISTENT A MEDIUMTERM ORIENTED CENTRAL BANK CAN LOOK THROUGH THE SHORTTERM INFLATIONEFFECTSASLONGASTHEREARENOSIGNSOF SIGNIFICANT SECONDROUND EFFECTS &ORCING A QUICK STABILISATION OF THE GENERAL PRICE LEVEL WOULDPUTTOOLARGEABURDENOFADJUSTMENTON THE STICKIER SECTORS "Y CONTRAST INFLATION SHOCKS THAT ORIGINATE FROM THOSE SECTORS SUCH AS SERVICES THAT ARE CHARACTERISED BY A SYSTEMATICALLYLONGERADJUSTMENTPROCESSSHOULD BEOFGREATERCONCERNTOTHEPOLICYMAKERAND MAYREQUIREAMOREPRONOUNCEDPOLICYRESPONSE 4O THESE CONCLUSIONS WE CAN ADD TWO FURTHER ELEMENTS FIRST THE SERVICES SECTOR IS MAINLY COMPOSEDOFITEMSTHATARENONTRADABLEACROSS COUNTRIESEVENINSIDETHECURRENCYUNIONAND THIS PREVENTS INTERNATIONAL COMPETITIVENESS WHICHCOULDOTHERWISEFOSTERANDSPEEDUPTHE NECESSARYADJUSTMENT3ECONDALARGESHAREOF THE VALUE ADDED OF THE SERVICES SECTOR IS ACCOUNTED FOR BY EMPLOYMENT COMPENSATION HINTING AT A RELATIONSHIP BETWEEN THE NOMINAL RIGIDITYOBSERVEDINTHESERVICESSECTORANDTHE WAGESETTINGMECHANISMS 36 $/7.7!2$02)#%&,%8)"),)49 /VERALLTHEREISLITTLEMICROEVIDENCETOSUGGEST THAT IT IS MORE DIFFICULT FOR FIRMS TO DECREASE PRICES THAN TO INCREASE THEM !S DISCUSSED ABOVEBOTHINTHERETAILANDTHEPRODUCERSECTOR ABOUTOFPRICECHANGESAREPRICEDECREASES -OREOVER THE ABSOLUTE SIZE OF THOSE PRICE DECREASESISLARGEANDINDEEDSOMEWHATLARGER THANTHESIZEOFPRICEINCREASES4HEFINDINGTHAT OVERALLPRICEFALLSAREVERYCOMMONCOULDHAVE IMPLICATIONSFORTHEOPTIMALINFLATIONOBJECTIVE )THASBEENARGUEDTHATDOWNWARDNOMINALPRICE RIGIDITIESTHATARENOTMATCHEDBYSIMILARUPWARD RIGIDITIESMAYJUSTIFYAHIGHERINFLATIONOBJECTIVE INORDERTOFACILITATERELATIVEPRICEADJUSTMENTIN AMONETARYUNIONFOLLOWINGASYMMETRICSECTORAL OR COUNTRY SHOCKS /VERALL THE )0. FINDINGS WOULD THEREFORE NOT SUGGEST THAT DOWNWARD NOMINALPRICERIGIDITIESAREANIMPORTANTREASON FOR HAVING SUCH AN INFLATION BUFFER (OWEVER THE SECTORAL HETEROGENEITY IS IMPORTANT IN THIS RESPECT)NTHESERVICESSECTORWHICHCONSTITUTES A LARGE FRACTION OF ITEMS IN THE ()#0 THE FREQUENCY OF PRICE DECREASES IS FOUND TO BE RELATIVELYLOW)NTHISSECTORONLYOFPRICE CHANGESAREPRICEDECREASES4HISMAYINPARTBE EXPLAINED BY HIGHER INFLATION RATES WHICH MAKES IT LESS NECESSARY TO DECREASE NOMINAL PRICES(OWEVERGIVENTHATTHESERVICESSECTOR HASALARGERLABOURINPUTSHAREANOTHERPOSSIBLE REASON FOR THIS ASYMMETRY IS THE STEADIER DEVELOPMENT OF WAGES WHICH MAY GO HAND IN HANDWITHDOWNWARDNOMINALWAGERIGIDITY)T REMAINS TO BE SEEN WHETHER SUCH DOWNWARD RIGIDITY IN WAGES IS A RELEVANT FACTOR FOR MAINTAINING AN INFLATION BUFFER &URTHERMORE THEASYMMETRYDISCOVEREDINTHESURVEYSPOINTS TO THE FACT THAT THERE IS LITTLE DOWNWARD PRICE RIGIDITY IN RESPONSE TO CHANGES IN DEMAND WHEREASTHISMAYBEMOREIMPORTANTINRESPONSE TOCHANGESINFIRMSCOSTS 3EE!LTISSIMO"ENIGNOAND2ODRIGUEZ &OR A DISCUSSION OF THE IMPORTANCE OF THE WAGESETTING MECHANISMINTHEPOLICYDESIGNSEE,EVIN/NATSKI7ILLIAMS AND7ILLIAMS #/.#,53)/. 4HE)0.HASPRODUCEDAWEALTHOFINFORMATION ON PRICESETTING AND INFLATION DYNAMICS IN THE EUROAREA4HEMAINFINDINGSMENTIONEDABOVE COVERONLYASMALLFRACTIONOFTHISINFORMATION 3OME OF THE )0. FINDINGS ON PRICESETTING PRACTICESCHALLENGESEVERALOFTHEASSUMPTIONS CURRENTLYUSEDINMICROFOUNDEDMACROECONOMIC MODELSOFINFLATIONDYNAMICS&OREXAMPLEIN CONTRAST TO THE ASSUMPTION MADE IN THE MOST POPULARINFLATIONMODELSTHATFIRMSONLYCHANGE THEIR PRICE AS A FUNCTION OF TIME AND IN A STAGGEREDFASHIONTHE)0.HASUNCOVEREDAMPLE EVIDENCE OF STATEDEPENDENCE IN PRICESETTING 4HE FREQUENCY OF PRICE CHANGES DEPENDS ON ECONOMICDEVELOPMENTSSUCHASCHANGESIN6!4 RATES THE LEVEL OF AGGREGATE AND SECTORAL INFLATION AND COLLECTIVE WAGE AGREEMENTS -OREOVER THE LARGE AVERAGE SIZE OF PRICE CHANGES SUGGESTS THAT IDIOSYNCRATIC SHOCKS AT THEFIRMLEVELAREALSOIMPORTANT3IMILARLYTHE )0.S SURVEY EVIDENCE SHOWS THAT LONGTERM RELATIONSHIPS WITH CUSTOMERS AND STRATEGIC INTERACTIONS AMONG FIRMS ARE IMPORTANT FOR PRICESETTINGINMANYINDUSTRIES 4HIS IMPROVED KNOWLEDGE ON PRICESETTING BEHAVIOURWILLALLOWRESEARCHERSTOBUILDMORE REALISTICMODELSWHICHSHOULDEVENTUALLYLEAD TO IMPROVED FORECASTING AND SIMULATION PERFORMANCE AND A BETTER BASIS FOR MONETARY POLICYMAKING&OREXAMPLEITWILLBEIMPORTANT TOINVESTIGATETHEEXTENTTOWHICHTHEEVIDENCE OFSIGNIFICANTSTATEDEPENDENCEINPRICESETTING AFFECTSTHEMACROBEHAVIOUROFINFLATIONINSUCH MODELS 3IMILARLY THE IMPLICATIONS OF THE IMPORTANCE OF LONGTERM RELATIONSHIPS AND STRATEGICFACTORSINPRICESETTINGWILLALSOBEAN IMPORTANT AREA FOR FUTURE RESEARCH 'IVEN THAT THIS RESEARCH HELPS TO BASE MACRO MODELS ON MORE ADEQUATE BEHAVIOURAL ASSUMPTIONS THE RELIABILITYOFPOLICYADVICEOBTAINEDWITHTHESE MODELSSHOULDALSOINCREASE!TTHESAMETIME THEREAREALREADYANUMBEROFFINDINGSTHATCAN ALREADY BE USED TO DRAW SOME TENTATIVE POLICY IMPLICATIONS 37 )N CLOSING THIS SUMMARY TWO OTHER ISSUES FOR FURTHER RESEARCH ARE WORTH MENTIONING &IRST THEREASONSBEHINDTHEDIFFERENCESBETWEENTHE EUROAREAANDTHE5NITED3TATESWITHRESPECTTO THE FREQUENCY OF PRICE CHANGES ARE NOT FULLY UNDERSTOOD 3ECOND AND PERHAPS MOST IMPORTANTLY THE RESULTS REPORTED HERE POINT TO AN IMPORTANT ROLE OF WAGE STICKINESS IN GENERATING PRICE STICKINESS )N ORDER TO UNDERSTANDINFLATIONDYNAMICSITWILLTHEREFORE ALSOBECRUCIALTOGAINABETTERUNDERSTANDINGOF THE FUNCTIONING OF LABOUR MARKETS IN THE EURO AREA !..%8 $%3#2)04)/./&4(%-)#2/$!4!3%43 4HISSECTIONDESCRIBESTHEDATABASESUNDERLYING THEEMPIRICALANALYSESCONDUCTEDBYTHE)0.AT THEMICROLEVEL4HEEVIDENCECOMESFROMTWO MAINTYPESOFDATASOURCESTHEFIRSTCONSISTSOF DIRECTINFORMATIONONINDIVIDUALPRICESATBOTH THE CONSUMER AND PRODUCER LEVELS THE SECOND CONSISTSOFONEOFFSURVEYSONPRICINGPOLICIES FOLLOWED BY FIRMS CONDUCTED SPECIFICALLY FOR THISPROJECT ).$)6)$5!,02)#%3!44(%#/.35-%2!.$ 02/$5#%2,%6%,3 4HEFIRSTTYPEOFDATAOBSERVATIONSONINDIVIDUAL PRICESWASAVAILABLEATBOTHTHECONSUMERAND PRODUCERLEVELS&ORCONSUMERPRICESTHE)0. RESEARCHTEAMSINSEVERAL.#"SOBTAINEDLARGE SETS OF ELEMENTARY DATABASES UNDERLYING THE CONSTRUCTIONOFTHECONSUMERPRICEINDICESFROM THE.ATIONAL3TATISTICAL/FFICES4HESEDATAARE AVAILABLE IN EURO AREA COUNTRIES !USTRIA "ELGIUM &INLAND &RANCE 'ERMANY )TALY ,UXEMBOURG THE .ETHERLANDS 0ORTUGAL AND 3PAINCOVERINGOFEUROAREA'$0"EFORE THE CREATION OF THE )0. THIS TYPE OF DATA WAS 4ABLE!#OVERAGEOFTHEMICRODATASOURCES #OUNTRY "ELGIUM 'ERMANY 'REECE 3PAIN &RANCE )RELAND )TALY ,UXEMBOURG 4HE.ETHERLANDS !USTRIA 0ORTUGAL &INLAND %UROAREACOVERAGE'$0WEIGHTS 0RODUCERPRICES #ONSUMER PRICES 1UALITATIVEDATA 1UANTITATIVE00) FROMBUSINESS DATA CYCLESURVEYS 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES 9ES !DHOCSURVEYS 4ABLE!#OVERAGEOFNATIONAL#0)DATABASES #OUNTRY "ELGIUM 'ERMANY 3PAIN &RANCE )TALY ,UXEMBOURG 4HE.ETHERLANDS !USTRIA 0ORTUGAL &INLAND 0ERCENTAGEOF#0)COVEREDORNUMBER OFPRODUCTCATEGORIES 0ERIODCOVERED PC PRODUCTCATEGORIESPC PC PC PRODUCTCATEGORIESPC PC PRODUCTCATEGORIESPC PCPCCONSIDERED PCPCCONSIDERED PC *ANUARYn$ECEMBER *ANUARYn*ANUARY *ANUARYn$ECEMBER *ULYn&EBRUARY *ANUARYn$ECEMBER *ANUARYn$ECEMBER .OVEMBERn!PRIL *ANUARYn$ECEMBER *ANUARYn*ANUARY *ANUARYn$ECEMBER 3OURCE"ELGIUM!UCREMANNEAND$HYNE'ERMANY(OFFMANNAND+URZ+IM3PAIN«LVAREZAND(ERNANDO &RANCE"AUDRY,E"IHAN3EVESTREAND4ARRIEU)TALY6ERONESE&ABIANI'ATTULLIAND3ABBATINI,UXEMBOURG,àNNEMANN AND-ATHÊ4HE.ETHERLANDS*ONKER&OLKERTSMAAND"LIJENBERG!USTRIA"AUMGARTNER'LATZER2UMLERAND3TIGLBAUER 0ORTUGAL$IAS$IASAND.EVES&INLAND6ILMUNENAND,AAKKONEN 38 ONLYAVAILABLETOALIMITEDEXTENTANDFORSPECIFIC PURPOSES IN "ELGIUM THE .ETHERLANDS AND 0ORTUGAL$ATAWERETYPICALLYMADEAVAILABLEON ABILATERALBASISBETWEENTHERESPECTIVENATIONAL STATISTICALOFFICESANDTHENATIONAL)0.TEAMSIN THE.#"SOFTHECORRESPONDINGCOUNTRIES$UE TOCONFIDENTIALITYCONSTRAINTSTHEDATABASESCAN ONLYBEACCESSEDBYTHESPECIFICNATIONALTEAM MAKINGITIMPOSSIBLETOPOOLTHENATIONALDATA SOURCES AND TO CONDUCT AN ANALYSIS DIRECTLY AT THEEUROAREALEVEL 4HETIMEDIMENSIONOFTHE#0)DATABASESVARIES ACROSS COUNTRIES 4HEY START AT THE END OF THE SORTHEBEGINNINGOFTHESIN"ELGIUM 0ORTUGAL 3PAIN AND &RANCE )TALY AND !USTRIA HAVE DATA AVAILABLE FROM &OR &INLAND 'ERMANY THE .ETHERLANDS AND ,UXEMBOURG SHORTERTIMESPANSARECOVEREDSTARTINGIN OR ! DETAILED OVERVIEW OF THE DATASETSISPROVIDEDIN$HYNEETAL &OR PRODUCER PRICES NATIONAL RESEARCH TEAMS WERE ABLE TO GATHER COMPARABLE STATISTICAL 4HE #0) DATABASES ARE TYPICALLY LARGE INFORMATION ON THE MICRO DATA UNDERLYING THE UNBALANCED PANELS OF PRICE QUOTES AT THE VERY NATIONAL PRODUCER PRICE INDICES FOR A FEW MICROLEVELIETHEPRICEOFAPARTICULARPRODUCT COUNTRIES ONLY 'ERMANY 3PAIN )TALY AND SOLD IN A GIVEN OUTLET 4HIS MEANS THAT THESE 4HE PRODUCT CATEGORIES SELECTED ARE UNPROCESSED FOOD DATABASES HAVE TWO TYPES OF CROSSSECTIONAL CATEGORIESSTEAKONETYPEOFFRESHFISHLETTUCEANDBANANAS DIMENSIONS AS WELL AS A TEMPORAL DIMENSION PROCESSEDFOODCATEGORIESMILKSUGARFROZENSPINACHMINERAL WATERCOFFEEWHISKYANDBEERENERGYOILPRODUCTSGASOLINE &IRST THEY COVER A WIDE RANGE OF DIFFERENT FOR HEATING PURPOSES AND TWO TYPES OF FUELS NONENERGY PRODUCTCATEGORIES4HEPRODUCTCOVERAGEVARIES INDUSTRIAL GOODS SOCKS JEANS SPORT SHOES SHIRT ACRYLIC PAINTINGCEMENTTOASTERELECTRICBULBONEPIECEOFFURNITURE ACROSS COUNTRIES 7HEREAS SEVEN NATIONAL TOWEL CAR TYRE TELEVISION SET DOG FOOD TENNIS BALL A ,EGO RESEARCH TEAMS HAVE AT THEIR DISPOSAL DETAILED CONSTRUCTIONGAMETOOTHPASTEANDSUITCASEANDSERVICESDRY PRICEQUOTESFORPRODUCTCATEGORIESWHICHCOVER CLEANINGHOURLYRATEOFANELECTRICIANHOURLYRATEOFAPLUMBER DOMESTICSERVICESHOURLYRATEOFAGARAGECARWASHBALANCING ATLEASTOFTHECONSUMPTIONBASKETOFTHEIR OF WHEELS TAXI CINEMA FAX MACHINE VIDEO RENTAL PHOTO COUNTRY !USTRIA "ELGIUM &INLAND &RANCE DEVELOPMENTHOTELROOMGLASSOFBEERINABARONEMEALINA RESTAURANTHOTDOGCOLABASEDLEMONADEINABARMENSHAIRCUT ,UXEMBOURG0ORTUGALAND3PAINAhMINIMUM AND LADIES HAIRDRESSING )F ONE PRODUCT CATEGORY WAS NOT COMMONSAMPLEvOFPRODUCTCATEGORIESWAS AVAILABLE IN ONE COUNTRY IT HAD TO BE REPLACED BY A CLOSE OBTAINED FOR THREE OTHER COUNTRIES 'ERMANY SUBSTITUTE 4HE PERIOD COVERED IN EACH COUNTRY HAS ALSO BEEN HARMONISEDEVENIFAFULLHARMONISATIONWASNOTPOSSIBLEASIT )TALY AND THE .ETHERLANDS 4HIS COMMON WASDECIDEDTOFOCUSONTHEPERIODSTARTINGIN*ANUARYAND SAMPLEWASDEFINEDINTHE)0.WITHTHEAIMOF NOT TO COVER THE PERIOD AFFECTED BY THE EURO CASH CHANGEOVER SINCETHISCOULDBIASFREQUENCIESOFPRICEADJUSTMENT(OWEVER ALLOWINGACOMPARISONOFRESULTS"ESIDESTHIS IF EXCLUDING THE EURO CASH CHANGEOVER PERIOD WOULD HAVE INTERMARKET DIMENSION THE DATA ALSO HAVE A SHORTENEDTHESAMPLEBYTOOMUCHITWASINCLUDED4HISWASTHE RICH INTRAMARKET DIMENSION AS FOR A GIVEN CASE FOR COUNTRIES 'ERMANY &INLAND AND ,UXEMBOURG 4HIS COULD BIAS UPWARDS THE AVERAGE FREQUENCY OF PRICE CHANGES IN PRODUCTCATEGORYEACHMONTHALARGENUMBEROF THESECOUNTRIESANDCONSEQUENTLYINTHEEUROAREAASAWHOLE INDIVIDUAL PRICES IS RECORDED IN DIFFERENT !DETAILEDPRESENTATIONOFTHISCOMMONSAMPLECANBEFOUNDIN OUTLETS $HYNEETAL 4ABLE!#OVERAGEOFNATIONAL00)DATABASES #OUNTRY 0ERCENTAGEOF00)COVEREDORNUMBER OFPRODUCTCATEGORIES 0ERIODCOVERED "ELGIUM 'ERMANY 3PAIN )TALY 0ORTUGAL PC PC PC PRODUCTS !LMOSTPC *ANUARYn*ANUARY *ANUARYn&EBRUARY .OVEMBERn&EBRUARY *ANUARYn$ECEMBER *ANUARYn!UGUST 3OURCE "ELGIUM $OSSCHE 'ERMANY6ERMEULEN ET AL 3PAIN «LVAREZ ET AL B )TALY 3ABBATINI ET AL 0ORTUGAL$IAS$IASAND.EVES 39 Portugal). These databases are, to a large extent, comparable to those described above for consumer prices. Price records relate to the exfactory price including all duties and taxes except VAT. The prices are actual transaction prices, not list prices (with the exception of Portugal). The price collected in period t should refer to orders booked during period t (moment of order) and not be recorded at the moment when the commodities leave the factory. As far as the number of product categories is concerned, also these databases cover either nearly the complete set of data available to the national statistical institutes (Germany, Spain and Portugal), or a “minimum common sample”, defined in the IPN (Italy). As far as the intramarket dimension is concerned, it is far less developed for the PPI than for the CPI, as the statistical information is typically obtained with production units, as opposed to outlets in the case of consumer prices. Although the time dimension of the databases is generally less developed than for CPI prices, available time spans still range from six to eight years. available to the national IPN teams. These data relate to the monthly business cycle surveys; the available information at the plant level corresponds to qualitative answers to questions referring to the price changes during the month under review and anticipations of price changes in the coming months. While having only qualitative information on the sign of price changes (up, down or unchanged), this type of data allows the pricing behaviour of the firm to be linked to other variables in the same survey, such as variations in demand. The countries where at least one of the two data sources on producer prices at the micro level is available represent approximately 85% of euro area GDP. A detailed overview of the datasets is provided in Vermeulen et al. (2005). AD HOC SURVEYS ON PRICING BEHAVIOUR OF FIRMS IN THE EURO AREA The second type of data comes from one-time surveys, conducted specifically for the IPN, on pricing policies followed by firms. Surveys were conducted in nine countries (Austria, Belgium, France, Germany, Italy, Luxembourg, the Netherlands, Portugal and Spain), covering 94% of euro area GDP. The surveys were In some cases (Belgium, France and Germany), a second type of data on producer prices is Table A4 Survey coverage (percentages of country survey, number of respondents in brackets) Country Industry Trade Other services Construction Total Belgium 38 (753) 100 (1228) 44 (888) 100 (1662) 65 (215) 20 (67) 18 (219) 76 (661) 84 (1157) 24 (478) - 18 (364) - 20 (384) - 26 (515) - 30 (605) - - 14 (46) 22 (73) 22 (271) - 20 (68) 37 (125) 60 (756) 24 (212) 16 (213) 1 (4) 22 (74) 100 (1979) 100 (1228) 100 (2008) 100 (1662) 100 (333) 100 (339) 100 (1246) 100 (879) 100 (1370) 21 (2343) 4 (462) Germany Spain France Italy Luxembourg The Netherlands Austria Portugal Euro area 62 (6850) 13 (1383) - - 100 (11038) Source: Fabiani et al. (2005). Percentages for the euro area are computed on the basis of the absolute figures reported in brackets, which are the sum of the firms in each category over the nine countries. 40 CONDUCTEDBYEACH.#"ATTHENATIONALLEVELTO TAKE ADVANTAGE OF THE EXISTING KNOWLEDGE IN THESE.#"SONSURVEYANDSAMPLEDESIGNANDOR TOADAPTTHELISTOFQUESTIONSTHEEXACTWORDING AND THE TECHNICAL ASPECTS OF THE SURVEY TO NATIONAL SPECIFICITIES #OMPARABILITY ACROSS COUNTRIESWASACHIEVEDBYMEANSOFCOORDINATION AT THE DIFFERENT STAGES OF THE PROJECT )N PARTICULAR A hMINIMUM COMMON SAMPLEv OF QUESTIONS WAS ADDRESSED IN EACH SURVEY AND ANALYSEDSUBSEQUENTLY !SSHOWNIN4ABLE!THENUMBEROFRESPONDENTS TOTHESURVEYSRANGEDFROMIN)TALYTO IN3PAIN/VERALLMORETHANENTERPRISES INTHEEUROAREAPARTICIPATEDINTHESURVEY!LL SURVEYS COVER THE MANUFACTURING SECTOR4RADE ANDOTHERSERVICESARECOVEREDINFIVEANDSEVEN COUNTRIES (OWEVER AS THESE SECTORS ARE NOT COVEREDINTHETWOLARGESTECONOMIESOFTHEEURO AREA'ERMANYAND&RANCETHE'$0WEIGHTSOF THECOUNTRIESCOVERINGTHESESECTORSONLYAMOUNT TO APPROXIMATELY #OVERAGE OF THE CONSTRUCTIONSECTORISVERYINCOMPLETEBOTHIN TERMSOFNUMBEROFCOUNTRIESANDCORRESPONDING '$0 WEIGHTS AND IN TERMS OF THE NUMBER OF INDIVIDUALFIRMSINTHESAMPLES 4HEAIMOFTHESURVEYSWASTOCOLLECTQUALITATIVE INFORMATIONWHICHCOULDCOMPLEMENTTHERESULTS OBTAINEDONTHEBASISOFTHEDATABASESOUTLINED IN THE PREVIOUS SUBSECTION 2ELATIVE TO THESE DATABASESADHOCSURVEYSHAVETHECOMPARATIVE ADVANTAGETHATTHEYCANDOCUMENTINQUALITATIVE TERMS THE UNDERLYING RATIONALE OF THE PRICING PATTERNS OBSERVED )N PARTICULAR SURVEYS CAN PROVIDEINSIGHTSINTOTHERELATIVEIMPORTANCEOF NOMINAL VERSUS REAL RIGIDITIES -OREOVER SURVEYSCANANALYSESEPARATELYTHETWOSTAGESIN THEPRICEADJUSTMENTPROCESSTHEPRICEREVIEWING ANDTHEPRICECHANGINGSTAGE&INALLYWHEREAS ITISNOTPOSSIBLEWITHTHE#0)AND00)DATABASES TO CHECK WHETHER A NEWLY SET PRICE IS SET IN A FULLY OPTIMISING WAY SURVEYS CAN ADDRESS THIS ISSUE BY ASKING FIRMS DIRECTLY WHICH TYPE OF INFORMATION THEY USE WHEN PRICES ARE REVIEWED 41 4HE MAJOR DRAWBACK OF SURVEYS IS THAT THE INFORMATIONTHEYPROVIDEISMAINLYQUALITATIVE IMPLYINGTHATITISSOMETIMESDIFFICULTTOGRASP THE PRECISE IMPORTANCE OF A GIVEN STATEMENT -OREOVER THEY TYPICALLY RELATE TO CURRENT OR RECENTPRICESETTINGPRACTICESANDDONOTMAKE IT POSSIBLE TO ADDRESS THE QUESTION OF WHETHER PRICINGPATTERNSCHANGEOVERTIME&INALLYTHEY ARE TYPICALLY SUBJECTIVE AND THEREFORE RESULTS COULDBESOMEWHATMISLEADING)TISREASSURING THAT THE RESULTS OBTAINED DO NOT APPARENTLY DEPEND ON THE WAY IN WHICH THE SURVEY WAS CONDUCTEDTHENUMBEROFQUESTIONSADDRESSED THE PRECISE WORDING AND THE LANGUAGE OF THE QUESTIONS AS WELL AS THE ORDERING OF THE QUESTIONS ANDOR OPTIONS WITHIN A PARTICULAR QUESTION 2ESULTS THEREFORE APPEAR TO BE RELATIVELYROBUST-OREDETAILSONTHESEDATAARE AVAILABLEIN&ABIANIETAL ")",)/'2!0(9 !DAM+AND-0ADULA)NFLATION$YNAMICSAND3UBJECTIVE%XPECTATIONSINTHE5NITED 3TATES%#"7ORKING0APER.O !LTISSIMO&-OJON"AND0:AFFARONI&AST-ICROAND3LOW-ACRO#AN!GGREGATION %XPLAINTHE0ERSISTENCEOF)NFLATION-IMEO%#" !LTISSIMO&0"ENIGNOAND$2ODRIGUEZ0ALENZUELA,ONG2UN$ETERMINANTSOF)NFLATION $IFFERENTIALSINA-ONETARY5NION#%02$ISCUSSION0APER.O !LTISSIMO&6#URDIAAND$2ODRIGUEZ0ALENZUELA,INEAR1UADRATIC!PPROXIMATIONTO /PTIMAL0OLICY!N!LGORITHMAND4WO!PPLICATIONS-IMEO%#" «LVAREZ,"URRIEL0AND)(ERNANDOA$ODECREASINGHAZARDFUNCTIONSFORPRICECHANGES MAKEANYSENSE%#"7ORKING0APER.O «LVAREZ,"URRIEL0AND)(ERNANDOB0RICE3ETTING"EHAVIOURIN3PAIN%VIDENCE&ROM -ICRO00)$ATA%#"7ORKING0APER.O «LVAREZ , AND ) (ERNANDO 0RICE 3ETTING "EHAVIOUR IN 3PAIN 3TYLISED &ACTS 5SING #ONSUMER0RICE-ICRO$ATA%#"7ORKING0APER.O «LVAREZ,AND)(ERNANDO4HE0RICE3ETTING"EHAVIOUROF3PANISH&IRMS%VIDENCEFROM 3URVEY$ATA%#"7ORKING0APER.O !MIRAULT $ +WAN # AND ' 7ILKINSON ! 3URVEY OF THE 0RICE3ETTING "EHAVIOUR OF #ANADIAN#OMPANIES"ANKOF#ANADA2EVIEW7INTER !NGELONI)!UCREMANNE,AND-#ICCARELLI0RICESETTINGANDINFLATIONPERSISTENCE $ID%-5MATTER0APERPRESENTEDATTHECONFERENCEh7HATEFFECTSIS%-5HAVINGONTHE EUROAREAANDITSMEMBERCOUNTRIESvSEEHTTPWWWECBINTEVENTSCONFERENCESHTMLEMU ENHTML !NGELONI )!UCREMANNE , %HRMANN - 'ALI * ,EVIN! AND & 3METS )NFLATION 0ERSISTENCE IN THE %URO !REA 0RELIMINARY 3UMMARY OF &INDINGS 0APER PRESENTED AT THE CONFERENCE h)NFLATION 0ERSISTENCE IN THE %URO !REAv SEE HTTPWWWECBINTEVENTS CONFERENCESHTMLINFLATIONPERSISTENCEENHTML !NGELONI ) #OENEN ' AND & 3METS 0ERSISTENCE THE 4RANSMISSION -ECHANISM AND 2OBUST-ONETARY0OLICY3COTTISH*OURNALOF0OLITICAL%CONOMY !NGELONI)AND-%HRMANN%URO!REA)NFLATION$IFFERENTIALS%#"7ORKING0APER.O !OKI + h/PTIMAL POLICY RESPONSE TO RELATIVE PRICE CHANGESv *OURNAL OF -ONETARY %CONOMICS6OLPAGES 42 !PEL - &RIBERG 2 AND + (ALLSTEN -ICRO &OUNDATIONS OF -ACROECONOMIC 0RICE !DJUSTMENT3URVEY%VIDENCEFROM3WEDISH&IRMS3VERIGES2IKSBANK7ORKING0APER.O !UCREMANNE , AND - #OLLIN (AS INFLATION PERSISTENCE CHANGED OVER TIME %VIDENCE FROMAGGREGATEANDSECTORAL"ELGIAN#0)DATA-IMEO.ATIONAL"ANKOF"ELGIUM !UCREMANNE,AND%$HYNE(OW&REQUENTLY$O0RICES#HANGE%VIDENCE"ASEDONTHE -ICRO$ATA5NDERLYINGTHE"ELGIAN#0)%#"7ORKING0APER.O !UCREMANNE,AND%$HYNEA4IMEDEPENDENTVERSUS3TATEDEPENDENT0RICING!0ANEL $ATA !PPROACH TO THE $ETERMINANTS OF "ELGIAN #ONSUMER 0RICE #HANGES %#" 7ORKING 0APER.O !UCREMANNE,AND%$HYNEB0RICEADJUSTMENTATTHEMICROLEVELISITJUSTLUMPYORIS ITALSOGRADUAL-IMEO.ATIONAL"ANKOF"ELGIUM !UCREMANNE,AND-$RUANT0RICESETTING"EHAVIOURIN"ELGIUM7HATCANBE,EARNED FROMAN!D(OC3URVEY%#"7ORKING0APER.O "ANKOF*APAN0RICE3ETTING"EHAVIOROF*APANESE#OMPANIES-IMEO"ANKOF*APAN "ATINI.%URO!REA)NFLATION0ERSISTENCE%#"7ORKING0APER.O "ATINI.AND%.ELSON4HE,AGFROM-ONETARY0OLICY!CTIONSTO)NFLATION&RIEDMAN 2EVISITED)NTERNATIONAL&INANCE¥ "AUDRY,,E"IHAN(3EVESTRE0AND34ARRIEU0RICE2IGIDITYIN&RANCE%VIDENCE FROM#ONSUMER0RICE-ICRO$ATA%#"7ORKING0APER.O "AUMGARTNER*%'LATZER22UMLERAND!3TIGLBAUER(OW&REQUENTLY$O#ONSUMER 0RICES#HANGEIN!USTRIA%VIDENCEFROM-ICRO#0)$ATA%#"7ORKING0APER.O "ENATI,)NVESTIGATING)NFLATION0ERSISTENCE!CROSS-ONETARY2EGIMES-IMEO"ANKOF %NGLAND "ENIGNO 0 /PTIMAL -ONETARY 0OLICY IN A #URRENCY !REA *OURNAL OF )NTERNATIONAL %CONOMICS "ENIGNO0AND$,OPEZ3ALIDO)NFLATION0ERSISTENCEAND/PTIMAL-ONETARY0OLICYINTHE %URO!REA%#"7ORKING0APER.O "ERBEN20-ESTRE2-ITRAKOS4-ORGAN*AND.:ONZILOS)NFLATION0ERSISTENCE IN3TRUCTURAL-ACROECONOMIC-ODELS%#"7ORKING0APER.O "ILKE,"REAKINTHE-EANAND0ERSISTENCEOF)NFLATION!3ECTORAL!NALYSISOF&RENCH #0)%#"7ORKING0APER.O 43 "ILS-AND0+LENOW3OME%VIDENCEONTHE)MPORTANCEOF3TICKY0RICES*OURNALOF 0OLITICAL%CONOMYPP "LANCHARD/AND*'ALI3UPPLYSHOCKSREALRIGIDITIESANDINFLATIONPERSISTENCE-IMEO -)4AND50& "LINDER!#ANETTI%,EBOW$AND*2UDD!SKING!BOUT0RICES!NEW!PPROACHTO 5NDERSTANDING0RICE3TICKINESS2USSELL3AGE&OUNDATION.EW9ORK "RAINARD 7 5NCERTAINTY AND THE EFFECTIVENESS OF POLICY !MERICAN %CONOMIC 2EVIEW 0APERSAND0ROCEEDINGS #ABALLERO2AND%%NGEL!DJUSTMENTIS-UCH3LOWER4HAN9OU4HINK."%27ORKING 0APER.O #ALVO'!3TAGGERED0RICINGINA5TILITY-AXIMIZING&RAMEWORK*OURNALOF-ONETARY %CONOMICS #ECCHETTI3AND'$EBELLE(ASTHE)NFLATION0ROCESS#HANGED")37ORKING0APER.O #HRISTOFFEL+AND4,INZERT4HEROLEOFREALWAGERIGIDITYANDLABORMARKETFRICTIONSFOR UNEMPLOYMENTANDINFLATIONDYNAMICS%#"7ORKING0APER.O #HRISTOFFEL++UESTER+AND4,INZERT4HE)MPACTOF,ABOR-ARKETSONTHE4RANSMISSION OF-ONETARY0OLICYINAN%STIMATED$3'%-ODEL-IMEO%#" #OENEN')NFLATION0ERSISTENCEAND2OBUST-ONETARY0OLICY$ESIGN%#"7ORKING0APER .O #OENEN ' AND! ,EVIN )DENTIFYING THE )NFLUENCES OF .OMINAL AND 2EAL 2IGIDITIES IN !GGREGATE0RICESETTING"EHAVIOUR%#"7ORKING0APER.O #OENEN'AND67IELAND!3MALL%STIMATED%URO!REA-ODELWITH2ATIONAL%XPECTATIONS AND.OMINAL2IGIDITIES%UROPEAN%CONOMIC2EVIEW #OGLEY4 AND4* 3ARGENT %VOLVING 0OST7ORLD7AR )) 53 )NFLATION $YNAMICS ."%2 -ACROECONOMICS!NNUAL-)40RESS #ORNILLE $ 4HE ADAPTATION OF PRICES TO THE CHANGEOVER TO THE EURO .ATIONAL "ANK OF "ELGIUM%CONOMIC2EVIEWTH4RIMESTER #ORVOISIER3AND"-OJON"REAKSINTHEMEANOFINFLATION(OWTHEYHAPPENANDWHAT TODOWITHTHEM%#"7ORKING0APER.O #RAINE2/PTIMALMONETARYPOLICYWITHUNCERTAINTY*OURNALOF%CONOMIC$YNAMICSAND #ONTROL 44 $E7ALQUE'3METS&AND27OUTERS0RICESETTINGINGENERALEQUILIBRIUMALTERNATIVE SPECIFICATIONS-IMEO.ATIONAL"ANKOF"ELGIUMAND%UROPEAN#ENTRAL"ANK $EXTER !3 ,EVI -$ AND "2 .AULT 3TICKY PRICES 4HE )MPACT OF 2EGULATION &ORTHCOMING*OURNALOF-ONETARY%CONOMICS $HYNE%«LVAREZ,,E"IHAN(6ERONESE'$IAS$(OFFMANN**ONKER.,àNNEMANN 02UMLER&AND*6ILMUNEN0RICESETTINGINTHEEUROAREA3OMESTYLISEDFACTSFROM )NDIVIDUAL#ONSUMER0RICE$ATA%#"7ORKING0APER.O $IAS-$IAS$AND0.EVES3TYLISED&EATURESOF0RICE3ETTING"EHAVIOURIN0ORTUGAL %#"7ORKING0APER.O $IAS$AND#2OBALO-ARQUES5SING-EAN2EVERSIONASA-EASUREOF0ERSISTENCE%#" 7ORKING0APER.O $IAS $ # 2OBALO -ARQUES AND * - # 3ANTOS 3ILVA 4IME OR 3TATE $EPENDENT 0RICE 3ETTING2ULES%VIDENCEFROM0ORTUGUESE-ICRODATA%#"7ORKING0APER.O $OSSCHE-4HE0ATTERNSOF0RICE3ETTINGINTHE"ELGIAN-ANUFACTURING)NDUSTRY-IMEO .ATIONAL"ANKOF"ELGIUM $OSSCHE-AND'%VERAERT-EASURING)NFLATION0ERSISTENCE!3TRUCTURAL4IME3ERIES !PPROACH%#"7ORKING0APER.O %#"$IRECT)MPACTOF#HANGESIN!DMINISTERED0RICESAND)NDIRECT4AXESON%URO!REA ()#0$EVELOPMENTS-ONTHLY"ULLETIN-ARCH %#"4HE)MPACTOF$EVELOPMENTSIN)NDIRECT4AXESAND!DMINISTERED0RICESON)NFLATION -ONTHLY"ULLETIN*ANUARY %HRMANN-AND&3METS5NCERTAINPOTENTIALOUTPUTIMPLICATIONSFORMONETARYPOLICY *OURNALOF%CONOMIC$YNAMICSAND#ONTROL %RCEG#*AND!4,EVIN)MPERFECT#REDIBILITYAND)NFLATION0ERSISTENCE&ORTHCOMING *OURNALOF-ONETARY%CONOMICS &ABIANI 3 $RUANT - (ERNANDO ) +WAPIL # ,ANDAU " ,OUPIAS # -ARTINS & -ATHÊ4 3ABBATINI23TAHL(AND!3TOKMAN4HE0RICING"EHAVIOUROF&IRMSINTHE%URO !REA.EW3URVEY%VIDENCE%#"7ORKING0APER.O &ABIANI3'ATULLI!AND23ABBATINI4HEPRICINGBEHAVIOUROF)TALIANFIRMSNEWSURVEY EVIDENCEONPRICESTICKINESS%#"7ORKING0APER.O &OUGÒRE$,E"IHAN(AND03EVESTRE(ETEROGENEITYIN#ONSUMER0RICE3TICKINESS! -ICROECONOMETRIC)NVESTIGATION%#"7ORKING0APER.O 45 'ADEA,AND,-AYORAL4HEPERSISTENCEOFINFLATIONININDUSTRIALCOUNTRIES&ORTHCOMING )NTERNATIONAL*OURNALOF#ENTRAL"ANKING 'ADZINSKI'AND&/RLANDI)NFLATIONPERSISTENCEFORTHE%5COUNTRIESTHEEUROAREAAND THE53%#"7ORKING0APER.O 'ALÓ*AND-'ERTLER)NFLATION$YNAMICS!3TRUCTURAL%CONOMETRIC!NALYSIS*OURNAL OF-ONETARY%CONOMICS 'ALÓ * 'ERTLER - AND $ ,ØPEZ3ALIDO %UROPEAN )NFLATION $YNAMICS %UROPEAN %CONOMIC2EVIEW 'ASPAR63METS&AND$6ESTIN!DAPTIVE,EARNING0ERSISTENCEAND/PTIMAL-ONETARY 0OLICY&ORTHCOMING*OURNALOFTHE%UROPEAN%CONOMIC!SSOCIATION 'OODFRIEND-AND2+ING4HE.EW.EO#LASSICAL3YNTHESISANDTHE2OLEOF-ONETARY 0OLICY."%2-ACROECONOMICS-ANUALPP 'ORDON27HYWAS%UROPELEFTATTHESTATIONWHEN!MERICASPRODUCTIVITYLOCOMOTIVE DEPARTED#%02$ISCUSSION0APER.O (ALL37ALSH-AND!9ATES!RE5+#OMPANIES0RICES3TICKY/XFORD%CONOMIC 0APERS (OEBERICHTS-AND!3TOKMAN0RICINGBEHAVIOUROF$UTCHCOMPANIESMAINRESULTSFROM ASURVEY-IMEO$E.EDERLANDSCHE"ANK (OFFMANN*AND*+URZ+IM#ONSUMERPRICEADJUSTMENTUNDERTHEMICROSCOPE'ERMANY INAPERIODOFLOWINFLATION-IMEO$EUTSCHE"UNDESBANK (ONDROYIANNIS ' AND 3 ,AZARETOU )NFLATION PERSISTENCE DURING PERIODS OF STRUCTURAL CHANGEANASSESSMENTUSING'REEKDATA%#"7ORKING0APER.O *ONDEAU%AND(,E"IHAN4ESTINGFORTHE.EW+EYNESIAN0HILLIPS#URVE!DDITIONAL )NTERNATIONAL%VIDENCE%CONOMIC-ODELLING *ONKER."LIJENBERG(AND#&OLKERTSMA%MPIRICALANALYSISOFPRICESETTINGBEHAVIOUR IN THE .ETHERLANDS IN THE PERIOD USING MICRO DATA %#" 7ORKING 0APER .O +LENOW0AND/+RYVTSOV3TATE$EPENDENTOR4IME$EPENDENT0RICING$OESIT-ATTER FOR2ECENT53)NFLATIONMIMEO +OZICKI3AND0!4INSLEY!LTERNATIVESOURCESOFTHELAGDYNAMICSOFINFLATION&EDERAL 2ESERVE"ANKOF+ANSAS#ITY7ORKING0APER.O +WAPIL#"AUMGARTNER*AND*3CHARLER4HE0RICESETTING"EHAVIOUROF!USTRIAN&IRMS 3OME3URVEY%VIDENCE%#"7ORKING0APER.O 46 ,EVIN!AND2-OESSNER)NFLATIONPERSISTENCEANDMONETARYPOLICYDESIGNANOVERVIEW %#"7ORKING0APER.O ,EVIN!4&-.ATALUCCIAND*-0IGER%XPLICITINFLATIONOBJECTIVESANDMACROECONOMIC OUTCOMES%#"7ORKING0APER.O ,EVIN!/NATSKI!7ILLIAMS*#AND.7ILLIAMS-ONETARYPOLICYUNDERUNCERTAINTY INMICROFOUNDEDMACROECONOMETRICMODELS&ORTHCOMING."%2-ACRO!NNUAL ,EVIN!4AND*-0IGER)SINFLATIONPERSISTENCEINTRINSICININDUSTRIALECONOMIES%#" 7ORKING0APER.O ,OUPIAS#AND22ICART0RICESETTINGIN&RANCENEWEVIDENCEFROMSURVEYDATA%#" 7ORKING0APER.O ,àNNEMANN0AND4-ATHÊ(OWPERSISTENTISDISAGGREGATEINFLATION!NANALYSISACROSS %5COUNTRIESAND()#0SUBINDICES%#"7ORKING0APER.O ,àNNEMANN 0 AND4 -ATHÊ A 2EGULATED AND SERVICES PRICES AND INFLATION PERSISTENCE %#"7ORKING0APER.O ,àNNEMANN0AND4-ATHÊB#ONSUMERPRICEBEHAVIOURIN,UXEMBOURGEVIDENCEFROM MICRO#0)DATA-IMEO"ANQUE#ENTRALEDU,UXEMBOURG -ARTINS&4HEPRICESETTINGBEHAVIOUROF0ORTUGUESEFIRMSEVIDENCEFROMSURVEYDATA %#"7ORKING0APER.O -C!DAM0AND!7ILLMAN.EW+EYNESIAN0HILLIPS#URVESAREASSESSMENTUSINGEURO AREADATA/XFORD"ULLETINOF%CONOMICSAND3TATISTICS -OESSNER 2 /PTIMAL DISCRETIONARY POLICY AND UNCERTAINTY ABOUT INFLATION PERSISTENCE %#"7ORKING0APER.O /2EILLY'AND+7HELAN(ASEUROAREAINFLATIONPERSISTENCECHANGEDOVERTIME%#" 7ORKING0APER.O /RPHANIDES ! AND *# 7ILLIAMS )MPERFECT +NOWLEDGE )NFLATION %XPECTATIONS AND -ONETARY 0OLICY FORTHCOMING IN 4HE )NFLATION 4ARGETING $EBATE " "ERNANKE AND - 7OODFORDEDS#HICAGO5NIVERSITYOF#HICAGO0RESS 0ALOVIITA - )NFLATION DYNAMICS IN THE EURO AREA AND THE ROLE OF EXPECTATIONS FURTHER RESULTS"ANKOF&INLAND$ISCUSSION0APER.O 0ALOVIITA-AND-6IREN4HE2OLEOF)NFLATION%XPECTATIONSINTHE)NFLATION0ROCESSIN THE%URO!REA"ANKOF&INLAND$ISCUSSION0APER.O 0ILAT $ 2EGULATION AND 0ERFORMANCE IN THE $ISTRIBUTION 3ECTOR /%#$ %CONOMICS $EPARTMENT7ORKING0APER.O 47 0IVETTAAND2EIS0ERSISTENCEOFINFLATIONINTHE5NITED3TATES-IMEO0RINCETON 2AVENNA&4HEIMPACTOFINFLATIONTARGETINGIN#ANADA!STRUCTURALANALYSIS-IMEO .95 2OBALO -ARQUES # )NFLATION PERSISTENCE &ACTS OR ARTEFACTS %#"7ORKING 0APER .O 2OBERTS*-.EW+EYNESIANECONOMICSANDTHE0HILLIPS#URVE*OURNALOF-ONEY#REDIT AND"ANKING 2OBERTS*-)SINFLATIONSTICKY*OURNALOF-ONETARY%CONOMICS 2OTEMBERG*-ONOPOLISTIC0RICE!DJUSTMENTAND!GGREGATE/UTPUT2EVIEWOF%CONOMIC 3TUDIES 2UMLER&%STIMATESOFTHEOPENECONOMY.EW+EYNESIAN0HILLIPS#URVEFOREUROAREA COUNTRIES%#"7ORKING0APER.O 3ABBATINI2&ABIANI3'ATULLI!AND'6ERONESE0RODUCER0RICE"EHAVIOURIN)TALY %VIDENCE&ROM-ICRO00)$ATA-IMEO"ANCAD)TALIA 3METS&-AINTAININGPRICESTABILITYHOWLONGISTHEMEDIUMTERM*OURNALOF-ONETARY %CONOMICS 3METS&AND27OUTERS!NESTIMATEDSTOCHASTICDYNAMICGENERALEQUILIBRIUMMODELOF THEEUROAREA*OURNALOF%UROPEAN%CONOMIC!SSOCIATION 3ÚDERSTRÚM 5 -ONETARY POLICY WITH UNCERTAIN PARAMETERS 3CANDINAVIAN *OURNAL OF %CONOMICS 3ONDERGAARD,%STIMATING.EW+EYNESIAN0HILLIPS#URVESIN%UROPE-IMEO'EORGETOWN 5NIVERSITY 3TAHL(4IMEDEPENDENTORSTATEDEPENDENTPRICESETTING-ICROEVIDENCEFROM'ERMAN METALWORKINGINDUSTRIES%#"7ORKING0APER.O 3VENSSON,)NFLATIONFORECASTTARGETINGIMPLEMENTINGANDMONITORINGINFLATIONTARGETS %UROPEAN%CONOMIC2EVIEW 4AYLOR*3TAGGERED0RICEAND7AGE3ETTINGIN-ACROECONOMICSIN4AYLORAND7OODFORD %DITORS(ANDBOOKOF-ACROECONOMICSVOLB.ORTH(OLLAND VAN DER #RUIJSEN # AND - $EMERTZIS 4HE )MPACT OF #ENTRAL "ANK 4RANSPARENCY ON )NFLATION%XPECTATIONS$."7ORKING0APER.O 48 6ERMEULEN0$IAS$(ERNANDO)3ABBATINI23EVESTRE0AND(3TAHL0RICE3ETTING INTHE%URO!REA3OME3TYLISED&ACTSFROM)NDIVIDUAL0RODUCER0RICE$ATAAND0RODUCER 3URVEYS-IMEO 6ERONESE ' &ABIANI 3 'ATTULLI! AND 3ABBATINI 2 #ONSUMER 0RICE "EHAVIOUR )N )TALY%VIDENCE&ROM-ICRO#0)$ATA%#"7ORKING0APER.O 6ILMUNEN * AND ( ,AAKKONEN (OW OFTEN DO PRICES CHANGE IN &INLAND -ICROLEVEL EVIDENCEFROMTHE#0)-IMEO"ANKOF&INLAND 7HELAN+3TAGGEREDPRICECONTRACTSANDINFLATIONPERSISTENCESOMEGENERALRESULTS%#" 7ORKING0APER.O 49 NATIONAL BANK OF BELGIUM - WORKING PAPERS SERIES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. "Model-based inflation forecasts and monetary policy rules" by M. Dombrecht and R. Wouters, Research Series, February 2000. "The use of robust estimators as measures of core inflation" by L. Aucremanne, Research Series, February 2000. "Performances économiques des Etats-Unis dans les années nonante" by A. Nyssens, P. Butzen, P. Bisciari, Document Series, March 2000. "A model with explicit expectations for Belgium" by P. Jeanfils, Research Series, March 2000. "Growth in an open economy: some recent developments" by S. Turnovsky, Research Series, May 2000. "Knowledge, technology and economic growth: an OECD perspective" by I. Visco, A. Bassanini, S. Scarpetta, Research Series, May 2000. "Fiscal policy and growth in the context of European integration" by P. Masson, Research Series, May 2000. "Economic growth and the labour market: Europe's challenge" by C. Wyplosz, Research Series, May 2000. "The role of the exchange rate in economic growth: a euro-zone perspective" by R. MacDonald, Research Series, May 2000. "Monetary union and economic growth" by J. Vickers, Research Series, May 2000. "Politique monétaire et prix des actifs: le cas des Etats-Unis" by Q. Wibaut, Document Series, August 2000. "The Belgian industrial confidence indicator: leading indicator of economic activity in the euro area?" by J.-J. Vanhaelen, L. Dresse, J. De Mulder, Document Series, November 2000. "Le financement des entreprises par capital-risque" by C. Rigo, Document Series, February 2001. "La nouvelle économie" by P. Bisciari, Document Series, March 2001. "De kostprijs van bankkredieten" by A. Bruggeman and R. Wouters, Document Series, April 2001. 16. "A guided tour of the world of rational expectations models and optimal policies" by Ph. Jeanfils, Research Series, May 2001. 17. "Attractive Prices and Euro - Rounding effects on inflation" by L. Aucremanne and D. Cornille, Documents Series, November 2001. 18. "The interest rate and credit channels in Belgium: an investigation with micro-level firm data" by P. Butzen, C. Fuss and Ph. Vermeulen, Research series, December 2001. 19 "Openness, imperfect exchange rate pass-through and monetary policy" by F. Smets and R. Wouters, Research series, March 2002. 20. "Inflation, relative prices and nominal rigidities" by L. Aucremanne, G. Brys, M. Hubert, P. J. Rousseeuw and A. Struyf, Research series, April 2002. 21. "Lifting the burden: fundamental tax reform and economic growth" by D. Jorgenson, Research series, May 2002. 22. "What do we know about investment under uncertainty?" by L. Trigeorgis, Research series, May 2002. 23. "Investment, uncertainty and irreversibility: evidence from Belgian accounting data" by D. Cassimon, P.-J. Engelen, H. Meersman, M. Van Wouwe, Research series, May 2002. 24. "The impact of uncertainty on investment plans" by P. Butzen, C. Fuss, Ph. Vermeulen, Research series, May 2002. 25. "Investment, protection, ownership, and the cost of capital" by Ch. P. Himmelberg, R. G. Hubbard, I. Love, Research series, May 2002. 26. "Finance, uncertainty and investment: assessing the gains and losses of a generalised non-linear structural approach using Belgian panel data", by M. Gérard, F. Verschueren, Research series, May 2002. 27. "Capital structure, firm liquidity and growth" by R. Anderson, Research series, May 2002. 28. "Structural modelling of investment and financial constraints: where do we stand?" by J.- B. Chatelain, Research series, May 2002. 29. "Financing and investment interdependencies in unquoted Belgian companies: the role of venture capital" by S. Manigart, K. Baeyens, I. Verschueren, Research series, May 2002. 30. "Development path and capital structure of Belgian biotechnology firms" by V. Bastin, A. Corhay, G. Hübner, P.-A. Michel, Research series, May 2002. 31. "Governance as a source of managerial discipline" by J. Franks, Research series, May 2002. NBB WORKING PAPER No. 95 - OCTOBER 2006 51 32. "Financing constraints, fixed capital and R&D investment decisions of Belgian firms" by M. Cincera, Research series, May 2002. 33. "Investment, R&D and liquidity constraints: a corporate governance approach to the Belgian evidence" by P. Van Cayseele, Research series, May 2002. 34. "On the Origins of the Franco-German EMU Controversies" by I. Maes, Research series, July 2002. 35. "An estimated dynamic stochastic general equilibrium model of the Euro Area", by F. Smets and R. Wouters, Research series, October 2002. 36. "The labour market and fiscal impact of labour tax reductions: The case of reduction of employers' social security contributions under a wage norm regime with automatic price indexing of wages", by K. Burggraeve and Ph. Du Caju, Research series, March 2003. 37. "Scope of asymmetries in the Euro Area", by S. Ide and Ph. Moës, Document series, March 2003. 38. "De autonijverheid in België: Het belang van het toeleveringsnetwerk rond de assemblage van personenauto's", by F. Coppens and G. van Gastel, Document series, June 2003. 39. "La consommation privée en Belgique", by B. Eugène, Ph. Jeanfils and B. Robert, Document series, June 2003. 40. "The process of European monetary integration: a comparison of the Belgian and Italian approaches", by I. Maes and L. Quaglia, Research series, August 2003. 41. "Stock market valuation in the United States", by P. Bisciari, A. Durré and A. Nyssens, Document series, November 2003. 42. "Modeling the Term Structure of Interest Rates: Where Do We Stand?, by K. Maes, Research series, February 2004. 43. Interbank Exposures: An Empirical Examination of System Risk in the Belgian Banking System, by H. Degryse and G. Nguyen, Research series, March 2004. 44. "How Frequently do Prices change? Evidence Based on the Micro Data Underlying the Belgian CPI", by L. Aucremanne and E. Dhyne, Research series, April 2004. 45. "Firms' investment decisions in response to demand and price uncertainty", by C. Fuss and Ph. Vermeulen, Research series, April 2004. 46. "SMEs and Bank Lending Relationships: the Impact of Mergers", by H. Degryse, N. Masschelein and J. Mitchell, Research series, May 2004. 47. "The Determinants of Pass-Through of Market Conditions to Bank Retail Interest Rates in Belgium", by F. De Graeve, O. De Jonghe and R. Vander Vennet, Research series, May 2004. 48. "Sectoral vs. country diversification benefits and downside risk", by M. Emiris, Research series, May 2004. 49. "How does liquidity react to stress periods in a limit order market?", by H. Beltran, A. Durré and P. Giot, Research series, May 2004. 50. "Financial consolidation and liquidity: prudential regulation and/or competition policy?", by P. Van Cayseele, Research series, May 2004. 51. "Basel II and Operational Risk: Implications for risk measurement and management in the financial sector", by A. Chapelle, Y. Crama, G. Hübner and J.-P. Peters, Research series, May 2004. 52. "The Efficiency and Stability of Banks and Markets", by F. Allen, Research series, May 2004. 53. "Does Financial Liberalization Spur Growth?" by G. Bekaert, C.R. Harvey and C. Lundblad, Research series, May 2004. 54. "Regulating Financial Conglomerates", by X. Freixas, G. Lóránth, A.D. Morrison and H.S. Shin, Research series, May 2004. 55. "Liquidity and Financial Market Stability", by M. O'Hara, Research series, May 2004. 56. "Economisch belang van de Vlaamse zeehavens: verslag 2002", by F. Lagneaux, Document series, June 2004. 57. "Determinants of Euro Term Structure of Credit Spreads", by A. Van Landschoot, Research series, July 2004. 58. "Macroeconomic and Monetary Policy-Making at the European Commission, from the Rome Treaties to the Hague Summit", by I. Maes, Research series, July 2004. 59. "Liberalisation of Network Industries: Is Electricity an Exception to the Rule?", by F. Coppens and D. Vivet, Document series, September 2004. 60. "Forecasting with a Bayesian DSGE model: an application to the euro area", by F. Smets and R. Wouters, Research series, September 2004. 61. "Comparing shocks and frictions in US and Euro Area Business Cycle: a Bayesian DSGE approach", by F. Smets and R. Wouters, Research series, October 2004. 52 NBB WORKING PAPER No. 95 - OCTOBER 2006 62. "Voting on Pensions: A Survey", by G. de Walque, Research series, October 2004. 63. "Asymmetric Growth and Inflation Developments in the Acceding Countries: A New Assessment", by S. Ide and P. Moës, Research series, October 2004. 64. "Importance économique du Port Autonome de Liège: rapport 2002", by F. Lagneaux, Document series, November 2004. 65. "Price-setting behaviour in Belgium: what can be learned from an ad hoc survey", by L. Aucremanne and M. Druant, Research series, March 2005. 66. "Time-dependent versus State-dependent Pricing: A Panel Data Approach to the Determinants of Belgian Consumer Price Changes", by L. Aucremanne and E. Dhyne, Research series, April 2005. 67. "Indirect effects – A formal definition and degrees of dependency as an alternative to technical coefficients", by F. Coppens, Research series, May 2005. 68. "Noname – A new quarterly model for Belgium", by Ph. Jeanfils and K. Burggraeve, Research series, May 2005. 69. "Economic importance of the Flemish maritime ports: report 2003", F. Lagneaux, Document series, May 2005. 70. "Measuring inflation persistence: a structural time series approach", M. Dossche and G. Everaert, Research series, June 2005. 71. "Financial intermediation theory and implications for the sources of value in structured finance markets", J. Mitchell, Document series, July 2005. 72. "Liquidity risk in securities settlement", J. Devriese and J. Mitchell, Research series, July 2005. 73. "An international analysis of earnings, stock prices and bond yields", A. Durré and P. Giot, Research series, September 2005. 74. "Price setting in the euro area: Some stylized facts from Individual Consumer Price Data", E. Dhyne, L. J. Álvarez, H. Le Bihan, G. Veronese, D. Dias, J. Hoffmann, N. Jonker, P. Lünnemann, F. Rumler and J. Vilmunen, Research series, September 2005. 75. "Importance économique du Port Autonome de Liège: rapport 2003", by F. Lagneaux, Document series, October 2005. 76. "The pricing behaviour of firms in the euro area: new survey evidence, by S. Fabiani, M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman, Research series, November 2005. 77. "Income uncertainty and aggregate consumption, by L. Pozzi, Research series, November 2005. 78. "Crédits aux particuliers - Analyse des données de la Centrale des Crédits aux Particuliers", by H. De Doncker, Document series, January 2006. 79. "Is there a difference between solicited and unsolicited bank ratings and, if so, why?" by P. Van Roy, Research series, February 2006. 80. "A generalised dynamic factor model for the Belgian economy - Useful business cycle indicators and GDP growth forecasts", by Ch. Van Nieuwenhuyze, Research series, February 2006. 81. "Réduction linéaire de cotisations patronales à la sécurité sociale et financement alternatif" by Ph. Jeanfils, L. Van Meensel, Ph. Du Caju, Y. Saks, K. Buysse and K. Van Cauter, Document series, March 2006. 82. "The patterns and determinants of price setting in the Belgian industry" by D. Cornille and M. Dossche, Research series, May 2006. 83. "A multi-factor model for the valuation and risk management of demand deposits" by H. Dewachter, M. Lyrio and K. Maes, Research series, May 2006. 84. "The single European electricity market: A long road to convergence", by F. Coppens and D. Vivet, Document series, May 2006. 85. "Firm-specific production factors in a DSGE model with Taylor price setting", by G. de Walque, F. Smets and R. Wouters, Research series, June 2006. 86. "Economic importance of the Belgian ports: Flemish maritime ports and Liège port complex - report 2004", by F. Lagneaux, Document series, June 2006. 87. "The response of firms' investment and financing to adverse cash flow shocks: the role of bank relationships", by C. Fuss and Ph. Vermeulen, Research series, July 2006. 88. "The term structure of interest rates in a DSGE model", by M. Emiris, Research series, July 2006. 89. "The production function approach to the Belgian output gap, Estimation of a Multivariate Structural Time Series Model", by Ph. Moës, Research series, September 2006. 90. "Industry Wage Differentials, Unobserved Ability, and Rent-Sharing: Evidence from Matched WorkerFirm Data, 1995-2002", by R. Plasman, F. Rycx and I. Tojerow, Research series, October 2006. NBB WORKING PAPER No. 95 - OCTOBER 2006 53 91. "The dynamics of trade and competition", by N. Chen, J. Imbs and A. Scott, Research series, October 2006. 92. "A New Keynesian Model with Unemployment", by O. Blanchard and J. Gali, Research series, October 2006. 93. "Price and Wage Setting in an Integrating Europe: Firm Level Evidence", by F. Abraham, J. Konings and S. Vanormelingen, Research series, October 2006. 94. "Simulation, estimation and welfare implications of monetary policies in a 3-country NOEM model", by J. Plasmans, T. Michalak and J. Fornero, Research series, October 2006. 95. "Inflation persistence and price-setting behaviour in the euro area: a summary of the Inflation Persistence Network evidence ", by F. Altissimo, M. Ehrmann and F. Smets, Research series, October 2006. 54 NBB WORKING PAPER No. 95 - OCTOBER 2006
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