State Dependent Or Time Dependent Pricing

Download or read book State-dependent Or Time-dependent Pricing written by Peter J. Klenow and published by Bank of Canada. This book was released on 2005 with total page 40 pages. Available in PDF, EPUB and Kindle. Book excerpt: Inflation equals the product of two terms: an extensive margin (the fraction of items with price changes) and an intensive margin (the average size of those price changes). The variance of inflation over time can be decomposed into contributions from each margin. The extensive margin figures importantly in many state-dependent pricing models, whereas the intensive margin is the sole source of inflation changes in staggered time-dependent pricing models. We use micro data collected by the U.S. Bureau of Labor Statistics to decompose the variance of consumer price inflation from 1988 through 2003. We find that around 95% of the variance of monthly inflation stems from fluctuations in the average size of price changes, i.e., the intensive margin. When we calibrate a prominent state-dependent pricing model to match this empirical variance decomposition, the model's shock responses are very close to those in time-dependent pricing models.