This award is funded under the American Recovery and Reinvestment Act of 2009 (Public Law 111-5).
I. Intellectual Merit. The nature of price setting by firms is central to many important questions in macroeconomics. Over the last few years, research on firm price setting has been transformed by the increased availability of micro price data. For several years, the PI's have been engaged in developing and analyzing the newly available micro price data at the U.S. Bureau of Labor Statistics (BLS). The goal of the current project is to continue this research along four dimensions. First, the PI's intend to work with the BLS to extend the academic research database on consumer prices further back in time. The current start date of this database is 1988. They hope to be able to extend the database back to the 1970's. This is of particular interest because inflation in the U.S. was much more variable in the 1970's and early 1980's than it has been since. They intend to use the expanded database to analyze how the frequency and size of price changes as well as the degree of price dispersion has varied over time. This will allow them to draw sharper conclusions about the success of different models of price setting than are possible using currently available data. Since the dataset will be constructed as a research database, they expect it will eventually be heavily used by future researchers both in academia and at the BLS. Second, they intend to analyze how product replacement affects exchange rate pass-through. In constructing price indices, price adjustments that occur at the time of product replacements tend to be dropped. If price adjustments disproportionately occur at the time of product replacements, then price adjustments are disproportionately unobserved. This will bias measures of exchange rate passthrough. The preliminary estimates suggest that this bias is large, potentially affecting estimates of exchange rate pass-through for the U.S. by as much as a factor of two. Third, they intend to use a large proprietary dataset we have obtained from AC Nielsen to analyze the comovement of retail prices across products, stores and cities in the U.S. The data consist of weekly prices and quantities for several thousand products and several thousand grocery stores over five years. Preliminary results suggest that a large part of retail price variation is due to dynamic pricing strategies as opposed to contemporaneous demand or supply shocks. The PI's are in the process of collecting an additional new dataset on manufacturer contracts that will allow them to extend their findings to answer the question of whether the observed variation in retail prices arises from complex price discrimination strategies by manufacturers or from dynamic pricing strategies by retailers. Fourth, they intend to use a new dataset on Icelandic consumer and import prices to analyze the role of local costs in explaining failures of purchasing power parity. Several existing studies of failures of purchasing power parity distinguish between traded and non-traded goods to try to evaluate the importance of local costs. An important concern regarding such studies is how to define tradable goods, since many goods that are in principle tradable are in practice rarely traded. The PI's aim to address these concerns by using the unique feature of the Icelandic consumer data that it identifies which products are, in fact, imported and which are not, and by matching the consumer price data with at-the-dock import prices to gauge the importance of non-traded distribution margins.
II. Broader Impact. The research is potentially highly relevant to policymakers at the Federal Reserve by shedding new light on the costs of inflation, the likely real effects of monetary policy and the effects of movements in the U.S. dollar on prices. The project involves the creation of a new historical dataset in collaboration with the BLS. This dataset will be made available to the academic community through the BLS outside researcher program. The PI's earlier research on this topic has been published in top academic journals and they intend to continue to disseminate their work in academic journals. Their prior research on this topic has also informed public discourse by being discussed in major news outlets such as The Economist and in undergraduate textbooks on macroeconomics.
