Understanding Price Stickiness: Firm‐level Evidence on Price Adjustment Lags and Their Asymmetries

Date01 October 2015
Published date01 October 2015
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
doi: 10.1111/obes.12083
Understanding Price Stickiness: Firm-level
Evidence on Price Adjustment Lags and Their
Daniel A. Dias†, Carlos Robalo Marques‡, Fernando Martins§
and J. M. C. Santos Silva
Department of Economics, University of Illinois at Urbana-Champaign and CEMAPRE,
10 David Kinley Hall, 1407 W Gregory Dr., Urbana, IL 61801, USA (e-mail: ddias@illi
Banco de Portugal, Av. Almirante Reis, 71, 1150-012, Lisboa, Portugal (e-mail: cmrmar
§Banco de Portugal, ISEG/University of Lisbon, and Universidade Lusíada de Lisboa, Av.
Almirante Reis, 71, 1150-012, Lisboa, Portugal (e-mail: fmartins@bportugal.pt)
University of Essex and CEMAPRE, Wivenhoe Park, Colchester, CO4 3SQ, UK (e-mail:
jmcss@essex.ac.uk )
We study the speed of price reactions to positive and negative demand and cost shocks.
Our findings suggest that price adjustment lags vary in line with the predictions of optimal
price setting models. Moreover, we find that the firms’reactions are asymmetric, and that
these asymmetries cannot be fully explained by anysingle theoretical model of asymmetric
price adjustment. Overall, these results suggest that the reaction to monetary policy shocks
may depend on which firms or sectors are particularly affected by them and, therefore, that
richer models are needed to fully understand the effects of monetary policy.
I. Introduction
Price stickiness has a central role in macroeconomics and, besides a vast theoretical liter-
ature, it has generated numerous empirical studies trying to explain its origins and gauge
its importance.
Most of the literature aimed at identifying the reasons of price stickiness has focused
on the frequency of price changes.1However, an important issue that arises when using
*Weare most grateful to the Editor Christopher Bowdler and to an anonymous referee for their many insightful and
helpful suggestions. We also thank NunoAlves, M´ario Centeno, Ana Cristina Leal, Jos´e Ferreira Machado, Stefan
Niemann, and Pedro Portugal for helpful discussions and useful suggestions. The opinions expressed in this article
are those of the authors and do not necessarily coincide with those of Banco de Portugal or the Eurosystem. Daniel
Dias and Jo˜ao Santos Silva gratefully acknowledge the partial financial support from Funda¸ao para a Ciˆencia e
Tecnologia(Programme PEst-OE/EGE/UI0491/2013). The usual disclaimer applies.
JEL Classification numbers: C41, D40, E31.
1See among others, Bils and Klenow (2004), Alvarez and Hernando (2005), Dhyne et al. (2006), Munnick and
Xu (2007), Klenow and Kryvtsov (2008), Gopinath and Itskhoki (2010), Klenow and Malin (2011), Druant et al.
(2012), and Vermeulen et al. (2012).
702 Bulletin
observed price changes to measure price rigidity at the micro-level is that the differences
in the frequency of price changes across products are not expected to strictly correspond
to differences in firm behaviour. Rather, the frequency of price changes is likely to also
depend in a significant way on the frequency and magnitude of the shocks that hit the firms
in the period under consideration. This suggests that the frequency of price changes is not
the best variable to use in empirical studies on the nature and origins of price rigidity. As
Blinder (1991, p. 94) puts it: ‘From the point of view of macroeconomic theory, frequency
of price change may not be the right question to ask, for it depends as much on the frequency
of shocks as on the firms’ pricing strategies.We are more interested to know howlong price
adjustments lag behind shocks to demand and cost’.
Therefore, rather than looking into the reasons for infrequent price changes, in this arti-
cle, we use survey data to directly investigate the deeper and more meaningful question of
the determinants of the speed of price reactions to demand and cost shocks.2Furthermore,
we study two important and intertwined forms of heterogeneity in the speed with which
firms respond to shocks.
First, we study between-firm heterogeneity by identifying firm-, product-, and market-
level characteristics that explain why some firms react faster than others to each of the
four types of shocks on which we have information. In line with theoretical models on
optimal price-setting rules (e.g. Barro, 1972; Caballero, 1989; Alvarez, Lippi and Paciello,
2011), we find evidence that the degree of price stickiness is influenced by variables that
are related to the importance of menu costs, the variability of the optimal price, and the
sensitivity of profits to sub-optimal prices. These results, therefore, lend support to the idea
that firms optimally choose the degree of price stickiness.
Second, we study within-firm heterogeneity by checking whetherfir ms react differently
to demand and cost shocks, and asymmetrically to positive and negative shocks (in a slight
abuse of terminology we refer to all these differences as asymmetries).We find that, in line
with similar evidence reported in the literature, most firms in our sample react faster to
positive than to negativecost shocks, and more quickly to negative than to positive demand
shocks. However, and more importantly, we also find that the direction and magnitude of
the asymmetries vary across firms and with the type of shock in a way that cannot be fully
explained by any single theoretical model of asymmetric price adjustment.
The results we present are important because the forms of heterogeneity in the speed
of firms’ responses to shocks that we find have implications for macroeconomic models
and monetary policy. First, it has been shown that the between-firm heterogeneity in price
stickiness leads monetary shocks to have larger and more persistent real effects (see, e.g.
Carvalho, 2006 and Nakamura and Steinsson, 2008). Second, the existence of within-
firm heterogeneity has important consequences for the relationship between inflation and
aggregate demand. The literature suggests that whether the Phillips curve is linear, concave
or convex depends on the existence and sign of the asymmetries in price rigidity at the
firm level (see, e.g. Buckle and Carlson, 1996; Laxton, Rose and Tambakis, 1999; Dolado,
Pedreiro and Ruge-Murcia, 2004; Dolado, Maria-Dolores and Naveira, 2005). Our results
2Other authors have studied similar survey data; see, e.g. Small andYates (1999), Fabiani, Gatulli and Sabbatini
(2004), Loupias and Ricart (2004), Alvarez and Hernando (2005), Kwapil, Baumgartner and Scharler (2005), and
Martins (2010). However, the main objective of these articles was to document and explain the existence of price
rigidity and not so much to study the determinants of the speed of price adjustments.
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd

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