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- 27 July 2007
- WORKING PAPER SERIES - No. 785Details
- The New Keynesian Phillips Curve is at the centre of two raging empirical debates. First, how can purely forward looking pricing account for the observed persistence in aggregate inflation. Second, price-setting responds to movements in marginal costs, which should therefore be the driving force to observed inflation dynamics. This is not always the case in typical estimations. In this paper, we show how heterogeneity in pricing behaviour is relevant to both questions. We detail the conditions under which imposing homogeneity results in overestimating a backward-looking component in (aggregate) inflation, and underestimating the importance of (aggregate) marginal costs for (aggregate) inflation. We provide intuition for the direction of these biases, and verify them in French data with information on prices and marginal costs at the industry level. We show that the apparent discrepancy in the estimated duration of nominal rigidities, as implied from aggregate or microeconomic data, can be fully attributable to a heterogeneity bias.
- JEL Code
- C10 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→General
C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
- ECB/CEPR labour market workshop on wage and labour cost dynamics