Advances in Macroeconomics and Econometrics

University Of California-San Diego, La Jolla CA

Investigators

Abstract

This research generates new insights into firms' price-setting behavior and develops guidelines that will be helpful in a wide range of applied econometric work. Two areas of research are proposed. The first project studies the question, why don't firms instantly adjust their prices to new economic fundamentals? This question gets to the heart of many of the central issues in economics. The novel suggestion here is to study a long time series with a sufficient number of observed price changes that we can make a useful statistical statement about the conditions under which an individual firm is predicted to change its price. A base-case menu cost model is shown to have the implication that the past history of prices and fundamentals should influence the probability of observing a price change only through the gap between the current price and fundamental value. A framework is proposed for testing this implication and quantifying and interpreting alternative dynamics that are observed in firms' actual prices. The second set of projects studies the role of normalization in econometrics. This issue, long thought to be irrelevant for substantive questions, has recently been shown to make a significant difference for the estimated impulse-response functions and confidence intervals as typically calculated in a number of models. This research proposal suggests a unifying principle that could be used to resolve both the problems that have already been documented as well as help in a number of econometric applications where this issue has yet to be recognized.