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From Hyperinflation to Stable Prices: Argentina's Evidence on Menu Cost Models

Work, Entrepreneurship, and Finance

We review and extend several comparative statics results of fixed menu cost models of price setting firms facing real idiosyncratic shocks, such as the type studied by Golosov and Lucas (2007). These results are confronted with their empirical counterparts using the micro data underlying Argentina's consumer price index for 1988-1997, when inflation rates went from almost 5000% during one year to less than zero. We find some empirical support for several theoretical predictions: (i) the steady state frequency of price changes is unresponsive to inflation for low inflation rates, while its elasticity with respect to inflation converges to close to 2/3 as inflation becomes large; (ii) the frequency of price increases is unresponsive to inflation and equal to the frequency of price decreases for small inflation rates, while the frequency of price decreases converges to zero as inflation increases; (iii) the average magnitude of price changes is symmetric for price increases and decreases at low inflation rates; while for high rates of inflation the magnitude of price increases is increasing with the inflation rate (for price decreases is less clearly so in the data); (iv) the steady state dispersion of relative prices is unresponsive to inflation for low rates while it is an increasing function of inflation for high rates of inflation; and (v) the variability of the frequency of price changes across goods diminishes as inflation grows. Our findings in (i) confirm and extend the cross country evidence available in the literature.

470wp.pdf (1.72 MB)
Author(s)
Fernando Alvarez
Martin Gonzalez-Rozada
Andy Neumeyer
Martin Beraja
Publication Date
January, 2013