Price adjustment in Costa Rica: a first assessment using micro-data.

Author:Vindas Quesada, Alberto Jose
Position:Articulo en ingles
Pages:96(16)
 

RESUMEN

Este articulo explora el proceso de ajuste de precios en Costa Rica, dando una mirada mas detallada a los microdatos que componen el indice de Precios al Consumidor para el periodo 2006-2013. La pregunta basica es si este proceso se asemeja a uno dependiente del tiempo, o a uno dependiente del estado. Esto se hace analizando una serie de regresiones de efectos aleatorios para explorar las relaciones entre tasa de inflacion, frecuencia de ajuste de precios y su magnitud promedio. Las principales conclusiones son que: 1) hay considerable heterogeneidad entre las categorias de producto, 2) las reducciones de precio siguen un patron muy estable que no depende de la tasa de inflacion, 3) el tamano promedio de los aumentos de precio es afectado levemente por la tasa de inflacion, 4) la proporcion de precios aumentando cada mes tiene una fuerte correlacion positiva con la tasa de inflacion, y 5) una especificacion dependiente del estado refleja mejor estos hechos

PALABRAS CLAVE: INFLACION, MACROECONOMIA, CICLO ECONOMICO, POLITICA MONETARIA, RIGIDEZ DE PRECIOS, IPC

ABSTRACT

This article explores the pricing adjustment process in Costa Rica, taking a deeper look into the micro-data that make up the Consumer Price Index for the period 2006-2013. The basic question asks if this process resembles time-dependent picing models, or if it resembles more a state-dependent process. This is done analysing a series of random effects regressions to explore the relations between inflation rate, frequency of pricing adjustments and their average magnitude. The main conclusions are that 1) there is considerable heterogeneity between product categories, 2) price decreases follow a very stable pattern that does not depend on the overall inflation rate, 3) the average size of the price increases is influenced by a very small magnitude by the inflation rate, 4) the proportion of prices increasing each month is strongly positively correlated with the inflation rate, and 5) state-dependent specifications fit better these facts.

KEY WORDS: INFLATION, MACROECONOMICS, ECONOMIC CYCLE, MONETARY POLICY, PRICE RIGIDITY, CPI

  1. INTRODUCTION

    Nominal rigidities are at the heart of the New Keynesian framework. One of the most popular ways in which these are implemented is price rigidity, which gives rise to the monetary non-neutrality central to this class of models. In the last years a series of studies using extensive and unpublished data from several consumer price indexes (CPI) have unveiled new information on the price adjustment process. Analysing several thousands of price quotes, different patterns and new questions have been established.

    This brief study contributes to the literature by doing an exploration of the price adjustment process in Costa Rica. This is the first time a study of this sort has been carried out with Costa Rican data due the confidentiality constraints surrounding a nationwide dataset such as the one gathered to calculate the CPI (2).

    The main focus of this study is to assess whether the pricing adjustment process follows more closely a time-dependent specification or a state-dependent one. Answering a relatively straightforward question does this: how big and how frequent are price changes, and how do these react to the overall inflation rate? Random effects models are used for this purpose, separating the cases for price increases and decreases which prove to be of critical importance.

    The evidence suggests that a state-dependent specification is more satisfactory than a time-dependent one. This is reflected by the fact that what varies the most in time is the fraction of price quotes increasing, while the fraction of price quotes decreasing and the average relative size for both increases and decreases do not vary significantly in time. The fraction of price increases is strongly positively correlated with the overall inflation rate, which gives support to a state-dependent pricing adjustment model. These findings closely resemble the ones found for different countries with lower and more stable inflation rates.

    This study is made up of nine sections, the first of which is this introduction. The second one discusses briefly the leading models of price rigidity. The third section has a literature review on the empirical studies of price rigidity using micro data. Section four describes the Costa Rican setting, while the fifth describes the dataset used. The sixth section provides an exploratory inspection of the data and the seventh presents the econometric analysis. The eighth section discusses the results and the ninth and final section concludes.

  2. THEORETICAL FRAMEWORK

    1. The Case for Sticky Prices in Macroeconomics

      According to Snowdon and Vane (2005), New Keynesian economics revolves around two important questions in macroeconomics: "Does the theory violate the classical dichotomy? That is, is money non-neutral?" and "Does the theory assume that real market imperfections in the economy are crucial for understanding economic fluctuations?" (Snowdon and Vane, 2005, p. 363). An important feature of macroeconomic modelling deals with observing the aggregate data and telling a story with a model. These should include elements consistent with how we believe the markets function, and as Walsh (2010) puts it, in macroeconomics most of the short run non-neutrality is not rationalised using imperfect information, or incomplete participation in financial markets, but introducing nominal rigidities.

      Gali and Gertler (2007) argue that the recent vintage of macroeconomic models bring to the table a mixture between elements of the real business cycle theory and the New Keynesian theory: quantitative modelling built from microfoundations that include nominal price stickiness. Because of this, they mention, the three most important additions to the real business cycle models are money, monopolistic competition, and nominal rigidities. In these models, money works as a unit of account (since we're now explicitly inserting the nominal sector), monopolistic competition is required to add a certain degree of price setting capacity by firms, and the nominal rigidities are the friction that give rise to the short run non-neutrality of money.

    2. Time-Dependent Price Setting

      As its name suggests, these models have a strong dependence on the time factor to perform adjustments. One of the earliest models in this fashion that took into account rational expectations was presented by Taylor (1980). Calvo (1983) provides an alternative to rationalise these rigidities: having firms changing prices only if they receive a signal to do so. This "Calvo fairy" assumption requires having a Poisson process determining the proportion of prices that will change each period.

      In New Keynesian models, the latter has become one of the most popular workhorses because of its ease of implementation and analysis. It still is widely used, but the new evidence on pricing adjustment tends to cast some scepticism on it because of the abstractions it makes: "While few macroeconomists would argue for this model as a literal description of how firms set prices, the goal of this 'Calvo model' is to provide a tractable model of price adjustment to be incorporated into general equilibrium business cycle models" (Nakamura and Steinsson, 2013, p. 8). Woodford (2008) comes to the defence of this specification, arguing that in the presence of high informational costs, the Calvo model proves to be a good enough approximation to the dynamics presented in more elaborate models.

    3. State-Dependent Price Setting

      State-dependent models rely on factors different from time to determine how firms decide to change prices. Its name is also suggestive of the fact that these models will take into account the state of the economy when taking pricing decisions. A popular example in this class of models was proposed by Rotemberg (1982). As Kashyap (1995) notes, firms decide not to continually adjust their prices and let inflation erode its set price because of the adjustment costs. This is a cost that is usually assumed fixed, and the policy followed by firms is to adjust their prices until a certain lower bound in their relative price is reached

      In these state-dependent models the timing of the adjustments is also endogenised, and as such price changes can take place in two dimensions: the extensive and intensive margin. The first one refers to the fact that after an inflationary shock, firms will react to it by increasing the size of the price changes. This is the only effect that is expected from time-dependent models, and the state-dependency includes the extensive margin. This margin opens the possibility that with the same inflationary shock, there will also be more firms changing their prices, so the adjustment will take place in both frequencies and magnitudes.

      Regarding state-dependent models, it can be noted that these "are generally less tractable than time-dependent models, thus accounting for their less frequent use. And prior to the availability of microeconomic data on price changes, time-dependent models were seen as adequate for modelling aggregate phenomena" (Walsh, 2010, p...

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