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Small and Large Price Changes and the Propagation of Monetary Shocks

Author

Listed:
  • Fernando Alvarez

    (University of Chicago)

  • Hervé Le Bihan

    (Banque de France)

  • Francesco Lippi

    (University of Sassari and EIEF)

Abstract
We present new evidence on the presence of both small and large price changes in individual price records from the CPI both in France and in the US. After correcting for measurement error and cross-section heterogeneity we find that the size distribution of price changes has a positive excess kurtosis,with a shape that lies between a Normal and a Laplace distribution. We construct a menu-cost model that is capable to reproduce the observed empirical patterns. The model, which features multiproduct firms and randomness in menu cost, has only 4 parameters, two of which are pinned down by the average frequency and by the standard deviation of price changes. Very different propagation mechanism, spanning the models of Taylor (1980), Calvo (1983) and Golosov and Lucas (2007), are nested under different combination of the remaining two parameters. We discuss the identification of these parameters using observations on the shape of the size-distribution of price changes (e.g. its kurtosis) and the actual cost of price adjustments borne by firms. We characterize analytically the response of the aggregate economy to a monetary shock, and how it depends on the variance and kurtosis, as well as on the frequency, of price changes.

Suggested Citation

  • Fernando Alvarez & Hervé Le Bihan & Francesco Lippi, 2013. "Small and Large Price Changes and the Propagation of Monetary Shocks," EIEF Working Papers Series 1318, Einaudi Institute for Economics and Finance (EIEF), revised Aug 2013.
    • Handle: RePEc:eie:wpaper:1318
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    References listed on IDEAS

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    Cited by:

    1. Carvalho, Carlos & Schwartzman, Felipe, 2015. "Selection and monetary non-neutrality in time-dependent pricing models," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 141-156.
    2. Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
    3. Roldan-Blanco, Pau & Gilbukh, Sonia, 2021. "Firm dynamics and pricing under customer capital accumulation," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 99-119.
    4. Fernando Alvarez & Francesco Lippi, 2016. "Price plans and the real effects of monetary policy," 2016 Meeting Papers 549, Society for Economic Dynamics.
    5. Berger, David & Vavra, Joseph, 2018. "Dynamics of the U.S. price distribution," European Economic Review, Elsevier, vol. 103(C), pages 60-82.
    6. Isaac Baley & J. Andrés Blanco, 2016. "Menu costs, uncertainty cycles, and the propagation of nominal shocks," Economics Working Papers 1532, Department of Economics and Business, Universitat Pompeu Fabra.
    7. Paulie, Charlotte, 2019. "Does Inflation Targeting Reduce the Dispersion of Price Setters’ Inflation Expectations?," Working Paper Series 2018:16, Uppsala University, Department of Economics.
    8. William (Bill) Zame & Jean-Paul L'Huillier, 2015. "Optimally Sticky Prices," 2015 Meeting Papers 621, Society for Economic Dynamics.
    9. Jacopo Magnani & Aspen Gorry & Ryan Oprea, 2016. "Time and State Dependence in an Ss Decision Experiment," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 285-310, January.
    10. Peter Karadi & Adam Reiff, 2019. "Menu Costs, Aggregate Fluctuations, and Large Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(3), pages 111-146, July.
    11. Amlendu Dubey & Juhi Lohani, 2022. "Inflation targeting and price behaviour: evidence from India," Indian Economic Review, Springer, vol. 57(2), pages 265-284, December.
    12. Paulie, Charlotte, 2019. "Does Inflation Targeting Reduce the Dispersion of Price Setters’ Inflation Expectations?," Working Paper Series 370, Sveriges Riksbank (Central Bank of Sweden).
    13. Donayre, Luiggi & Panovska, Irina, 2016. "State-dependent exchange rate pass-through behavior," Journal of International Money and Finance, Elsevier, vol. 64(C), pages 170-195.
    14. Peng Zhou & Huw Dixon, 2019. "The Determinants of Price Rigidity in the UK: Analysis of the CPI and PPI Microdata and Application to Macrodata Modelling," Manchester School, University of Manchester, vol. 87(5), pages 640-677, September.

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    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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