Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153886
Authors: 
Karadi, Peter
Reiff, Adam
Year of Publication: 
2012
Series/Report no.: 
ECB Working Paper 1453
Abstract: 
How do prices react to large aggregate shocks? Our new micro-data evidence on value-added tax changes shows that prices react (i) flexibly and (ii) asymmetrically to large positive and negative shocks. We use it to quantitatively evaluate the performance of prominent pricing models. We show that standard time-dependent models are unable to reproduce either of these facts. A realistically calibrated state-dependent menu cost model, in contrast, is successful in matching the observed price responses. Its success lies in its ability to capture the exploding fraction of price changes for large shocks. The evidence facilitates comparison of different menu cost models and raises doubts on alternative pricing models with information or search frictions as sole reasons for price rigidity.
Subjects: 
Inflation asymmetry
state-dependent pricing
time-dependent pricing
value-added tax shock
JEL: 
E31
E52
Document Type: 
Working Paper

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