Academic journal article Journal of Money, Credit & Banking

Heterogeneity in Price Rigidity: Evidence from a Case Study Using Microlevel Data

Academic journal article Journal of Money, Credit & Banking

Heterogeneity in Price Rigidity: Evidence from a Case Study Using Microlevel Data

Article excerpt

VARIATION IN PRICE RIGIDITY is an issue of considerable Interest in macroeconomics because understanding its reasons may shed light on causes of price rigidity. (1) For example, according to Gordon (1981, p. 517), understanding it "is crucial for the theory of price adjustment." Caplin (1993, p. 21) describes it as unfortunate "that so little attention has been given to characterizing the circumstances that give rise to high and low levels of nominal price inertia. Progress in this dimension calls for more detailed empirical work and for increased understanding of the manner in which corporations actually arrive at pricing decisions." Weiss (1993, p. 15) also suggests to include all "relevant information at the level of the firm, including costs and demand data." Similarly, Lach and Tsiddon (1992, p. 351) suggest to use actual transaction prices to study price rigidity because they "most closely resemble the data envisioned by the cost of adjustment theory: price quotations at the level of the price setter." Unfortunately, only a handful of studies use actual transaction prices to study price rigidity (Kashyap 1995, Genesove 1999).

We combine two unique data sets to create a microlevel case study of time-varying price rigidity. The first data set consists of weekly retail, wholesale, and commodity prices for twelve orange juice products which are categorized as either refrigerated or frozen. A unique feature of this data set is that it contains two episodes of exogenous commodity cost shocks. The cost-price data suggest that manufacturers' and retailer's reactions to the shocks were different. Specifically, we find that prices exhibit significantly more rigidity in response to the second shock than the first.

To explain this variation in price rigidity we collected a second data set consisting of all public information on the cost shocks. Because it is difficult to know what information economic agents have and use, macroeconomists usually are forced to make assumptions of various kinds about the content of this information. For example, many empirical macroeconomic studies that make use of anticipated/unanticipated series rely on forecast-generating equations to generate these series. We, in contrast, study a very specific product market where determination of the relevant information set is less ambiguous in comparison to studies that use aggregate data. Thus, we collected all publicly available information we could find about the causes and effects of the cost shocks, and by analyzing the content of these information, we are able to assess the extent of the actual information the orange juice market participants likely had. We shall also note the novelty of the method we use to identify shock persistence. In macroeconomics, identification of temporary and permanent components of shocks is usually accomplished by econometric means. The reason for this practice is that it is difficult to know how market participants assess economic variables' persistence. We are able to overcome this difficulty by focusing on specific cost shocks and by studying in detail their actual causes and effects and the events surrounding them, we are able to evaluate their likely permanence.

We find that (i) the first cost shock was larger than the second, (ii) the first shock was more persistent than the second, and (iii) the market had more information on the first shock than the second. These findings, therefore, suggest that prices are more flexible in response to cost shocks that are larger in size, more persistent, and on which the market participants have more information. This conclusion is particularly valuable because the nature of the price rigidity we are documenting enables us to control for various market features that are frequently used to explain variation in price rigidity. For example, over the three-year sample period, the market structure and industry concentration, the nature of long term relationships, contractual arrangements, and the number of stages of processing, all have remained unchanged. …

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