International Evidence on the Setting of Individual Consumer Prices - - PowerPoint PPT Presentation

International Evidence on the Setting

• f Individual Consumer Prices

Etienne Gagnon Federal Reserve Board A presentation to the 10th meeting of the Ottawa Group, October 10th, 2007.

The views expressed in this presentation and associated paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System, or any other person associated with the Federal Reserve System.

October 10th, 2007 Etienne Gagnon - FRB

Context

World economies are constantly hit by shocks

monetary injections; exchange rates swings; productivity gains; fiscal stimuli; changes in tariffs; etc.

It is widely believed that the failure of individual

prices to adjust in response to shocks has real effects on the economy

makes the economy more volatile, deepening

recessions and exacerbating expansions;

leads to more persistent effects of shocks.

October 10th, 2007 Etienne Gagnon - FRB

Context

Although price stickiness has been at the hearth

• f the macroeconomic debate since Keynes

(1936), the amount of evidence on the adjustment of individual prices was embarrassingly small until very recently.

The situation is changing dramatically, however,

as statistical agencies worldwide are increasingly making available to researchers the micro data they collect for the purpose of computing price indices.

October 10th, 2007 Etienne Gagnon - FRB

Context

These data bases are almost ideal for assessing

the extent of price stickiness in the economy:

monthly data; tens of thousand of individual items; indicator of ongoing sales or promotions; type of outlet; representative of consumption basket; representative of points of purchase.

October 10th, 2007 Etienne Gagnon - FRB

Mexican CPI micro data base

Period

January 1994 to December 2006

Price quotes

Total: 8.5 million Per month: 30-85 thousand Median item observed for about 5 years

Coverage

302-315 product categories 2/3 consumption expenditures

October 10th, 2007 Etienne Gagnon - FRB

Outline

Overview of countries that have done studies

using CPI micro data base.

Two key findings from Mexico

Price stickiness and inflation, VAT pass-through to individual prices.

October 10th, 2007 Etienne Gagnon - FRB

Inflation and time coverage of CPI studies

• 5%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Four-quarter change in official CPI USA

Bils and Klenow (2004)

October 10th, 2007 Etienne Gagnon - FRB

Inflation and time coverage of CPI studies

• 5%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Four-quarter change in official CPI USA

Klenow and Kryvtsov (2005)

October 10th, 2007 Etienne Gagnon - FRB

Inflation and time coverage of CPI studies

• 5%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Four-quarter change in official CPI AUT BEL DEN FIN FRA JAP LUX PRT ESP USA

October 10th, 2007 Etienne Gagnon - FRB

Inflation and time coverage of CPI studies

• 5%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Four-quarter change in official CPI AUT BEL DEN FIN FRA JAP LUX PRT ESP USA MEX

October 10th, 2007 Etienne Gagnon - FRB

Basic inflation accounting

Inflation can be decomposed as:

where frt Average frequency of price changes dpt Average magnitude of nonzero price changes

t  frt  dpt

October 10th, 2007 Etienne Gagnon - FRB

Frequency of price changes and inflation

94 95 96 97 98 99 00 01 02

• 10

10 20 30 40 50 60 70 80 frequency of price changes inflation

October 10th, 2007 Etienne Gagnon - FRB

94 95 96 97 98 99 00 01 02 10 20 30 40 50 60 70

%

changes increases decreases

Frequency of price changes and inflation

October 10th, 2007 Etienne Gagnon - FRB

Magnitude of price changes and inflation

94 95 96 97 98 99 00 01 02

• 5

5 10 15 20

%

average price change average price increase average price decrease

October 10th, 2007 Etienne Gagnon - FRB

April 1995 VAT change

94m10 95m1 95m4 95m7 95m10 5 10

%

a) inflation - general rate 94m10 95m1 95m4 95m7 95m10 5 10

%

b) inflation - excluded items 94m10 95m1 95m4 95m7 95m10 20 40 60 80

%

c) frequency - general rate 94m10 95m1 95m4 95m7 95m10 20 40 60 80

%

d) frequency - excluded items 94m10 95m1 95m4 95m7 95m10 5 10 15

%

e) magnitude - general rate 94m10 95m1 95m4 95m7 95m10 5 10 15

%

f) magnitude - excluded items Note: The sample is broken dow n betw een items that are taxed (general rate) and those that are not (excluded items). It is further divided betw een geographic areas w here the general rate changed in April 1995 (center) and those w here it remained the same (border). center border center border center border center border center border center border

October 10th, 2007 Etienne Gagnon - FRB

Conclusion (1/2)

Our understanding of how individual prices are set

is expanding rapidly, thanks to researchers worldwide gaining access to large panels of data.

We now have a clearer idea of the degree of price

• stickiness. We also better understand the

response of individual prices to some shocks, as illustrated by the Mexican data.

This abundance of new facts has spurred an

enormous amount of research geared at improving economics models.

October 10th, 2007 Etienne Gagnon - FRB

Conclusion (2/2)

Much remains to be learnt using these data

bases, however,

Is price stickiness changing as larger retailers

expand (ex. Wal-Mart entering the Mexican market)?

How does the appearance and disappearance of

items impact price stickiness and the economy’s response to shock?

How do shocks get transmitted from commodities,

to producers, and then to retailers?

What is the degree of exchange rate pass-through

to import prices? And to individual prices?