Working Paper: CEPR ID: DP6184
Authors: Jean Imbs; Eric Jondeau; Florian Pelgrin
Abstract: 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.
Keywords: heterogeneity; inflation persistence; marginal costs; New Keynesian Phillips curve; nominal rigidities
JEL Codes: C10; C22; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Ignoring heterogeneity in pricing (D49) | Overestimation of backward-looking behavior in inflation dynamics (E31) |
| Ignoring heterogeneity in pricing (D49) | Underestimation of the importance of marginal costs (D40) |
| Accounting for heterogeneity (C21) | Decrease in estimated proportion of backward-looking behavior (D91) |
| Differences in duration of nominal rigidities across sectors (E39) | Biases in aggregate estimations (C51) |
| Incorporating heterogeneity (D29) | Improvement in understanding of inflation dynamics (E31) |