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Title:What drives the relationship between inflation and price dispersion? Market power vs. price rigidity PDF Logo
Authors:Becker, Sascha
Issue Date:2011
Series/Report no.:SFB 649 discussion paper 2011-019
Abstract:Recent monetary search and Calvo-type models predict that the relationship between inflation and price dispersion is U-shaped, implying an optimal rate of inflation above zero. Moreover, monetary search models emphasize a critical dependence of the real effects of inflation on sellers' market power, whereas Calvotype models suggest that the degree of price rigidity significantly affects the inflation - price dispersion nexus. Using a new set of highly disaggregated sectoral price data from a panel of European countries, this paper contributes to the literature by testing the empirical relevance of these two theoretical predictions. In line with monetary search theory, a U-shaped profile is found, provided that markups are sufficiently high, but the relationship breaks down under a more competitive environment. Contrarily, no evidence is found to support the contentions of Calvo-type models: U-shaped effects of inflation occur in product sectors with sticky as well as highly flexible prices.
relative price variability
price level index
market structure
monetary search model
dynamic panel data models
Document Type:Working Paper
Appears in Collections:SFB 649 Discussion Papers, HU Berlin

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