Calvo Pricing Research Articles

The Estimation of Traditional Phillips Curve

This article presents theoretical foundations for original Phillips curve formulation and an empirical investigation, where the structure of the theoretical model serves as a template for the creation of the empirical model.For a couple of decades the majority of empirical Phillips curve type assessments are performed using the New Keynesian Phillips curve with Calvo pricing as a benchmark for this type of relationship. New Keynesian model has solid microeconomic foundations, has proved itself very well in the analysis of price stickiness; nevertheless, it is not without limitations. The main insufficiency of New Keynesian model is that it has no direct links to the conditions and the changes that occur in the labour market. The need to encompass the conditions in labour market comes from the coincides that occur time to time when the growth rates of aggregate production may diminish or even become negative, but the level of employment may stay the same, what in turn means that the pressure on inflation won’t drop, despite the fact that production level has not increased as expected or even has decreased. This article aims to fill this gap and presents alternative theoretical foundations for Phillips curve, that lead to the model with direct links to the labour market. Theoretical foundations are necessary as they may help to minimize the risks to miss some important details or to omit important factors. Although the empirical analysis in this paper is based on Lithuanian data, it is not country specific.

The risk premium in New Keynesian DSGE models: The cost of inflation channel

We study the role of the cost of inflation channel in determining the risk premium in a (nonlinear) New Keynesian DSGE model. Relying on a Calvo (or Rotemberg) price setting, we show that while the cost of inflation channel generates the desired term premium moments, it suffers from nontrivial, counterintuitive approximation errors in the price dispersion function. In addition to documenting the issues, we propose ways to alleviate them, including a quasikinked demand function as a risk-generating mechanism.

Information loss in volatility measurement with flat price trading

A model of financial asset price determination is proposed that incorporates flat trading features into an efficient price process. The model involves the superposition of a Brownian semimartingale process for the efficient price and a Bernoulli process that determines the extent of flat price trading. The approach is related to sticky price modeling and the Calvo pricing mechanism in macroeconomic dynamics. A limit theory for the conventional realized volatility (RV) measure of integrated volatility is developed. The results show that RV is still consistent but has an inflated asymptotic variance that depends on the probability of flat trading. Estimated quarticity is similarly affected, so that both the feasible central limit theorem and the inferential framework suggested in Barndorff-Nielsen and Shephard (J Royal Stat Soc Ser B (Stat Methodol) 64:253–280, 2002) remain valid under flat price trading even though there is information loss due to flat trading effects. The results are related to work by Jacod (J Financ Econom 16:526–569, 2018) and Mykland and Zhang (Ann Stat 34:1931–1963, 2006) on realized volatility measures with random and intermittent sampling, and to ACD models for irregularly spaced transactions data. Extensions are given to include models with microstructure noise. Some simulation results are reported. Empirical evaluations with tick-by-tick data indicate that the effect of flat trading on the limit theory under microstructure noise is likely to be minor in most cases, thereby affirming the relevance of existing approaches.

The extended perturbation method: With applications to the New Keynesian model and the zero lower bound

We introduce the extended perturbation method, which improves the accuracy of standard perturbation by reducing approximation errors under certainty equivalence. For the New Keynesian model with Calvo pricing, extended perturbation is more accurate than standard perturbation, which implies explosive dynamics because it omits the upper bound on inflation implied by this model. In contrast, extended perturbation enforces this bound and generates stable dynamics. We also show that extended perturbation can accurately solve a New Keynesian model that enforces the zero lower bound for the monetary policy rate by considering a smooth nonlinear modification of the standard Taylor rule.

Undesired Consequences of Calvo Pricing in a Non-linear World

Undesired Consequences of Calvo Pricing in a Non-linear World

Price Dispersion and the Costs of Inflation

AbstractThe new Keynesian literature typically makes the assumption that firms always have to satisfy demand, which is at odds with profit‐maximizing behavior under Calvo pricing when long‐run inflation is positive. Our model, which relaxes this assumption, predicts that inflation causes a substantially smaller loss in effective aggregate productivity compared to a benchmark model without the possibility of rationing. Moreover, under positive inflation, firms choose smaller markups over marginal costs in our model than in the benchmark model. As a result, our analysis suggests that the standard new Keynesian model may exaggerate the welfare costs of inflation.

Price Stickiness in US-Corn Market: Evidence from Dsge-Var Simulation

Abstract This study examines price stickiness in the United States (US) corn market using annual series data, on the dollar price of corn per bushel, obtained from the United States Department of Agriculture (USDA) and Federal Reserve Bank of Saint Louis (FRED), between 1930 and 2017. The study implemented the Calvo price stick model based on an agent in a general equilibrium and New Keynesian type, simulated using DSGE-VAR. The approach permits the indexing formula to include expected corn inflation rather than lagged inflation. The results show that corn price inflation only persists by 2% every trading year, resulting from changes in the immediate future corn-price inflation and output-gap, respectively. The shock to stochastic term only causes a partial decline in the corn price, converging at a future date with its long-run equilibrium. The experiment confirmed that corn price fluctuations are beyond the purview of the domestic economy, and any attempt to impose price policies will offset the price setting, creating further distortions and a wider gap in the corn yield. The study provides fresh insight into the Calvo price stick model of the New Keynesian type and its use to forecast agricultural outcomes.

ОЦІНЮВАННЯ ГІБРИДНОЇ НЕОКЕЙНСІАНСЬКОЇ КРИВОЇ ФІЛЛІПСА ДЛЯ УКРАЇНИ

The Hybrid New Keynesian Phillips Curve (HNKPC) was developed as a response to the apparent inertia in inflation the baseline New Keynesian Phillips curve leaved unexplained. Thus, the hybrid model combines two extreme cases – the traditional Phillips curve, and the purely forward-looking NKPC. The HNKPC also based on theoretical micro-foundations that aim to explain price stickiness and nominal rigidities. The paper is devoted to econometric testing and investigation the validity of the HNKPC (Calvo pricing model) for Ukraine. We use both the output gap and the marginal cost as the relevant indicators of real economic activity to determine the most appropriate one for Ukraine. Using the monthly data for the period 2016–2020, the main object is to compare the impact of both forward- and backward-looking components on inflation dynamic. Results of estimation by the Generalized Method of Moments (GMM) show that inflation possess resistant backward inertia due to domination of backwardlooking behaviour. Our findings indicate that the degree of price stickiness in Ukraine is found to be quite low, while the fraction of firms using the backward-looking rule in price setting is rather high. These estimates seem plausible from an economic point of view but not optimistic in terms of inflation targeting. The results provide useful insights for inflation dynamics and can be useful for improving monetary policy efficiency in Ukraine

Degree of monopoly and market power vs. price flexibility in Polish economy: empirical analysis based on COICOP classification

Research background: The issue of price flexibility is crucial in the economy both in the aspect of company theory and its macroeconomic consequences. In a number of publications, the sources of variable price flexibility are linked to the market power of enterprises as well as the market structure that has developed in a given branch. It is difficult to indicate empirical studies that would state clearly whether price flexibility depends on the degree of monopoly or the market power of enterprises. This paper concerns that particular field of study.
 Purpose of the article: The purpose of the paper is to present the statistical dependence of the degree of monopoly and market power vs. price flexibility in the economy.
 Methods: The analysis has been conducted using aggregated data concerning Polish economy in the period from 2001 to 2013, based on COICOP. The degree of monopoly indicator was the average number of companies in a given branch, following the classical models of market structures; the market power indicator was the average net revenue from sales of products per enterprise representing a given branch; the measure of price flexibility was the probability of price variation estimated using the Calvo pricing model. It is, therefore, a frequency-based approach to price flexibility. Statistical dependence was analyzed using the Spearman's rank and Kendall?s tau correlation coefficient and simple regression models.
 Findings & Value added: The outcomes indicate that in the case of Poland in the analyzed period there is no statistically significant relation between the degree of monopoly and price flexibility and also between the market power and price flexibility. Thus, the findings of the analysis support the studies which reject the assumption that higher degree of monopoly or higher market power of an enterprise is followed by less flexible prices.

Welfare consequences of inconsistent monetary policy implementation in Vietnam

We develop a New Keynesian model featuring Calvo price setting and Calvo wage setting to quantify the welfare consequences of shifting trend inflation in Vietnam. To capture the characteristics of the Vietnamese economy, we use the Simulated Method of Moment and calibrate parameters jointly to match the important selected moments of Vietnamese data. The results show a severe consequence of a constant positive trend inflation and an exogenous shock to trend inflation, especially when a central bank sets a high level of inflation target. Among staggered price and wage contracts, the latter play a vital role in transmitting the adverse impacts of constant and shifting trend inflation into the economy. Based on our analyses, raising inflation targets would seem to be a bad policy prescription in Vietnam.

Discussion

Discussion

Discretionary monetary policy in the Calvo model

We study discretionary equilibrium in the Calvo pricing model for a monetary authority that chooses the money supply. The steady-state inflation rate is above eight percent for a baseline calibration, but it varies substantially with alternative structural parameter values. If the initial condition involves inflation higher than steady state, discretionary policy generates an immediate drop in inflation followed by a gradual increase to the steady state. Unlike the twoperiod Taylor model, discretionary policy in the Calvo model does not accommodate predetermined prices in a way that inevitably leads to multiple private-sector equilibria.

Real exchange rate convergence: The roles of price stickiness and monetary policy

In many open-economy models based on Dornbusch (1976), the speed of convergence of the real exchange rate is tied to the stickiness of prices. The “purchasing power parity puzzle” concerns the empirical fact that real exchange rates appear to converge more slowly than nominal prices. In some New Keynesian models, when there is no interest-rate smoothing, the stickiness of prices does not matter at all for persistence, as Benigno (2004) showed. We show that in the presence of interest-rate smoothing, price stickiness does matter and endogenous real-exchange rate persistence is bounded above by the interest rate smoothing parameter and by the probability of a firm not changing prices under Calvo pricing. We also explain the relationship between the New Keynesian framework with Calvo pricing, and the Dornbusch framework where price stickiness is integral to real exchange rate convergence.

Price Dispersion and the Costs of Inflation

The new Keynesian literature typically makes the assumption that firms always have to satisfy demand. Because this assumption is at odds with profit-maximizing behavior under Calvo pricing when long-run inflation is positive, we present a new Keynesian model that relaxes this assumption. Our model predicts that inflation causes a substantially smaller loss in effective aggregate productivity compared to a benchmark model without the possibility of rationing. Moreover, under positive inflation, firms choose smaller markups over marginal costs in our model than in the benchmark model. As a result, our analysis suggests that the standard new Keynesian model may exaggerate the welfare costs of inflation. We also show that the effects are plausible to be quantitatively important.

Optimal monetary policy in the presence of food price subsidies

Food price subsidies are a prevalent means by which fiscal authorities may counteract food price volatility in middle-income countries (MIC). We develop a DSGE model for a MIC that captures this key channel of a policy induced price smoothing mechanism that is different to, yet in parallel with, the classic Calvo price stickiness approach, which can have consequential effects for monetary policy. We then use the model to address how the joint fiscal and monetary policy responds to an increase in inflation driven by a food price shock can affect welfare. We show that, in the presence of credit constrained households and households with a significant share of food expenditures, a coordinated reaction of fiscal and monetary policies via subsidized price targeting can improve aggregate welfare. Subsidies smooth prices and consumption, especially for credit constrained households, which can consequently result in an interest rate reaction less intensely with subsidized price targeting compared with headline price targeting.

Estimated DSGE Model for Monetary and Fiscal Polic Coordination Analysis – The Case of Serbia

Abstract We present a new-Keynesian model for small open economy, with price rigidities stemming from a Calvo pricing scheme (1983), monopolistic banking system, financial dollarization of the economy and monetary and fiscal policy governed by rules. We estimate the model on Serbian data and propose various model extensions that could be used for monetary and fiscal policy analysis. We consider 6 combinations of monetary and fiscal policy regimes, inflation targeting and currency peg on one hand, and discretionary cyclically neutral fiscal policy and fiscal rules, on the other. The model with inflation targeting and discretionary fiscal policy fits the data best.

Comment

Comment

Is Rotemberg pricing justified by macro data?

Structural models used to study monetary policy often include sticky prices. Calvo pricing is more common but Rotemberg pricing has become popular due to its computational advantage. To determine whether the data supports that change, we estimate a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint and each type of sticky prices. The models produce similar parameter estimates and the filtered shocks are nearly identical when the Fed was not constrained, but the Rotemberg model has a higher marginal data density and it endogenously generates more volatility at the ZLB, which helps explain data from 2008–2011.

Plastic to fuel and wax

Structural models used to study monetary policy often include sticky prices. Calvo pricing is more common but Rotemberg pricing has become popular due to its computational advantage. To determine whether the data supports that change, we estimate a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint and each type of sticky prices. The models produce similar parameter estimates and the filtered shocks are nearly identical when the Fed was not constrained, but the Rotemberg model has a higher marginal data density and it endogenously generates more volatility at the ZLB, which helps explain data from 2008–2011.

Trade openness and inflation: The role of real and nominal price rigidities

The paper revisits the long-standing question of the impact of trade openness on the inflation–output trade-off by accounting for the effects of product market competition on price flexibility. The study develops a New-Keynesian open-economy dynamic stochastic general equilibrium model with non-constant price elasticity of demand and Calvo price setting in which the frequency of price adjustment is endogenously determined. It demonstrates that trade openness has two opposing effects on the sensitivity of inflation to output fluctuations. On the one hand, it raises strategic complementarity in firms' pricing decisions and the degree of real price rigidities, which makes inflation less responsive to changes in real marginal cost. On the other hand, it strengthens firms' incentives to adjust their prices, thereby reducing the degree of nominal price rigidities and increasing the sensitivity of inflation to changes in marginal cost. The study explains the positive relationship between competition and the frequency of price adjustment observed in the data. It also provides new insights into the effects of global economic integration on the Phillips Curve.