International Evidence on the Setting of Individual Consumer Prices Etienne Gagnon Federal Reserve Board A presentation to the 10 th meeting of the Ottawa Group, October 10 th , 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.
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 of 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 45% 40% 35% Four-quarter change in official CPI 30% 25% 20% 15% 10% Bils and Klenow (2004) 5% 0% -5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 USA October 10th, 2007 Etienne Gagnon - FRB
Inflation and time coverage of CPI studies 45% 40% 35% Four-quarter change in official CPI 30% 25% 20% 15% 10% Klenow and Kryvtsov (2005) 5% 0% -5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 USA October 10th, 2007 Etienne Gagnon - FRB
Inflation and time coverage of CPI studies 45% 40% 35% Four-quarter change in official CPI 30% 25% 20% 15% 10% 5% 0% -5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 AUT BEL DEN FIN FRA JAP LUX PRT ESP USA October 10th, 2007 Etienne Gagnon - FRB
Inflation and time coverage of CPI studies 45% 40% 35% Four-quarter change in official CPI 30% 25% 20% 15% 10% 5% 0% -5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 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: t fr t dp t where fr t Average frequency of price changes dp t Average magnitude of nonzero price changes October 10th, 2007 Etienne Gagnon - FRB
Frequency of price changes and inflation 80 70 60 50 40 30 20 10 0 -10 94 95 96 97 98 99 00 01 02 frequency of price changes inflation October 10th, 2007 Etienne Gagnon - FRB
Frequency of price changes and inflation 70 changes increases 60 decreases 50 40 % 30 20 10 0 94 95 96 97 98 99 00 01 02 October 10th, 2007 Etienne Gagnon - FRB
Magnitude of price changes and inflation 20 15 10 % 5 0 -5 94 95 96 97 98 99 00 01 02 average price change average price increase average price decrease October 10th, 2007 Etienne Gagnon - FRB
April 1995 VAT change b) inflation - excluded items a) inflation - general rate 10 10 center center border border 5 5 % % 0 0 94m10 95m1 95m4 95m7 95m10 94m10 95m1 95m4 95m7 95m10 c) frequency - general rate d) frequency - excluded items 80 80 center center 60 border 60 border 40 40 % % 20 20 0 0 94m10 95m1 95m4 95m7 95m10 94m10 95m1 95m4 95m7 95m10 e) magnitude - general rate f) magnitude - excluded items 15 15 center center border border 10 10 % % 5 5 0 0 94m10 95m1 95m4 95m7 95m10 94m10 95m1 95m4 95m7 95m10 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). 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? October 10th, 2007 Etienne Gagnon - FRB
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