Monetary Shocks, Market Structure, and Administered Prices

Abstract

This paper examines interindustry variation in the response of prices to nominal aggregate demand disturbances. This subject has been the focus of numerous investigations in recent years [7; 8; 9; 10; 11; 12; 13; 17 and 28]. A long standing motivation for this attention has been debate over Gardiner Means's [22] administered (AP) thesis; which, in broad terms, seems to imply that cyclical price flexibility diminishes with increases in market power.' More recently, researchers have focused on imperfect competition as a source of price stickiness because of the importance of this mechanism for the emerging Keynesian analysis of business cycles, [1; 3; 6]. Thus far however, the empirical studies on this subject have reported mixed results, and the relationship between imperfect competition and price flexibility remains unsettled. Curiously, an alternative to the market power explanation of inter-industry variation in cyclical price flexibility has been largely ignored in these past studies even though it lies at the heart of the new classical macro models. The Lucas [21] supply function (LSF), which is key to the striking policy results of these models, predicts that output will respond more to a demand shockand by implication, absolute prices will respond less-in those industries with a history of greater variation in their relative demand or price. Industry level investigation of price movements thus provides a partial test of the LSF which, like the AP thesis, remains open to question. This paper presents evidence on the explanatory power of both the AP and the LSF approaches. We begin with a price change equation that can be derived from a standard LSF model as shown by Robert Gordon [15]. An important feature of this specification is its distinction between anticipated and unanticipated money growth. We then show that this same price equation can be given an AP interpretation, relying principally on recent work of Rotemberg and Saloner [29]. Both approaches predict variation across industries in their price response to unanticipated money growth, but they offer different explanations of the cause. The LSF theory suggests dependence on the industry's relative demand instability. The AP models suggest dependence on industry structure. Evidence on the competing theories is developed from annual price data on 328 four-digit