CAREER: Analysis of Prices, Informational Rigidities and Productivity Differences

University Of California-Berkeley, Berkeley CA

Investigators

Abstract

This project is aimed to address three key questions in macroeconomics. The first question is, To what extent are prices inflexible, what is the best way to measure the degree of price stickiness, and what are the implications for macroeconomic dynamics and optimal policy design? This question is related to one of the central debates in macroeconomics, which is whether nominal shocks have significant real effects. While there is evidence that prices at the micro level could indeed be fixed for short periods of time, sales often interrupt fairly long intervals of otherwise stable prices. Specifically, temporary sales could be a form of price flexibility for firms that are unable to adjust their regular or ?reference? prices, i.e. prices that tend to remain fixed for prolonged periods of time. Thus, when firms want to lower prices, they do not have to change their regular prices. Instead, they introduce deeper and more frequent sales so that the effective price paid by consumers is lower than suggested by the regular price. In this scenario, the effective prices could be much more flexible and procyclical over the business cycle than regular prices and therefore the rationale for countercyclical policy could be considerably undermined. Likewise, consumers can change outlets to seek better prices and thus make prices actually paid in transactions more flexible than is implied by posted prices. The latter could be particularly important in e-commerce where search costs are minimal and consumers can easily switch outlets not only from one seller to another in response to economic conditions but also switch away from regular brick-and-mortar stores which typically charge higher prices for identical goods relative to online stores. This project will study cyclical properties of sales and outlet substitution as well as properties of prices in online markets which is an increasingly important segment in the retail industry. Apart from improving design of countercyclical policies, this project will also be informative for enhancing price indexes constructed by the Bureau of Labor Statistics and other private and public agencies. For example, this project can provide guidelines on sampling techniques (e.g., sample discount stores and online markets more during downturns), types of collected data (e.g., use prices actually paid rather than posted prices; collect quantities), and aggregation (e.g., use expenditure weights potentially differentiated across types of stores rather than apply a uniform weight for a product category). The second question is, What is the role of information rigidities in determining the behavior of macroeconomic aggregates and individual economic agents? How economic agents form their expectations has long been one of the most fundamental questions in macroeconomics. Indeed, the abandonment of adaptive expectations in favor of rational expectations was one of the defining features in the rebuilding of macroeconomics starting in the 1970s and most modern macroeconomic models assume full-information rational expectations on the part of all agents. Recent events, however, have called into question the general validity of models analyzed under the assumption of full-information rational expectations. For example, the freezing of interbank lending markets in 2008 reflected in part uncertainty about the financial positions of other institutions, a feature at odds with the full-information assumption of modern macroeconomic models and the notion that prices incorporate all pertinent information. Coming to grips with such informational constraints will undoubtedly be a fundamental component of post-crisis macroeconomic models. While there has been some recent theoretical work focused on better understanding the frictions and limitations faced by economic agents in the acquisition and processing of information, this research has been hampered by a lack of robust empirical evidence that quantifies these concepts. This project will develop and use a general framework to document, classify and quantify the nature of information rigidities faced by different agents. This framework can not only be used to directly map models of informational imperfections to empirical counterparts but can also be readily applied to a variety of economic agents such as professional forecasters, consumers, firms, central banks, and financial markets. Since informational frictions can explain numerous features of the data which are difficult to reconcile with the common assumption of full-information, this project, by providing a robust set of stylized facts about informational rigidities, will lay the groundwork for a more empirically justified theory of information constraints. This will shed light on one of the most fundamental questions in economics, the nature of the expectations formation process, and will be directly applicable to a variety of fields in economics. The results of the project will be relevant to policy-makers for several reasons. First, the nature of the informational frictions has critical implications for welfare calculations and hence the design of optimal policy. By assessing which informational frictions are quantitatively important, this project will provide a key ingredient for policy analyses. Second, the project will formally investigate the interaction of informational frictions faced by different types of agents especially when one type of agents (e.g., the central bank) may have an informational advantage and thus policy changes may induces indirect effects on the economy through agents? learning about economic conditions from policy changes. Finally, the nature of informational frictions can impact how policy changes should be implemented. For example, whether policymakers should be opaque or transparent about the current and future course of actions crucially depends on how economic agents collect and process information. The third question is, What is the source of productivity and income differences across countries? It is widely perceived that the key conduit of economic growth and productivity enhancements is innovation that brings new goods and services to the economy as well as new ways to produce existing goods and services. Obviously, many factors such as quality of property rights, development of financial markets and ownership structure affect the intensity of innovation and a great deal of effort was put into studying these factors. However, it is surprising that although Max Weber and others have argued that culture played a fundamental role in explaining the wealth of nations and the literature on the economic effects of culture is growing fast, there has so far been little systematic work examining theoretically and empirically the effect of culture on innovation, productivity and development. This project is aimed to broadly explore sources of variation in productivity and innovation with an emphasis on cultural differences. Specifically, the project will investigate how culture affects individual choices to deviate from norms and try new technologies and goods, how culture influences allocation of resources and specialization in trade, how culture contributes to political constraints on economic behavior and provision of public goods. The project will also study co-evolution of genes and cultural/economic outcomes over long periods of time. The results of this project will be instrumental in understanding cultural constraints and thus will help to enhance developmental policies by building on existing cultures and their strengths instead of transposing policies that are not adequate to a given cultural environment. Apart from providing economists with new insights into key questions about development and its interplay with culture, this project is meant to bridge economics to other disciplines such as sociology, political science, anthropology, psychology, and genetics.