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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.
Subjects:inflation
relative price variability
price level index
Euro-area
market structure
monetary search model
dynamic panel data models
JEL:C23
D40
E31
F15
Document Type:Working Paper
Appears in Collections:SFB 649 Discussion Papers, HU Berlin

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