Monday, March 7, 2016

Interview with Emi Nakamura: Price Stickiness and Shocks

Renee Haltom has an "Interview" with Emi Nakamura in Econ Focus, published by the Federal Reserve Bank of Richmond (Third Quarter 2015, pp. 26-30). Much of her work focuses on measurements of price stickiness, and then implications of those facts for the effects of macroeconomic policies and outcomes. Here are a few of the comments that jumped out at me.

Sales,  Price Stickiness, Demand Shocks
"All this means that even if we were to see a huge number of price changes in the micro data, the aggregate inflation rate may still be pretty sticky. And if one abstracts from the huge number of sales in retail price data, then prices look a lot less flexible than they first appear. ... It turns out sales have quite special characteristics that suggest that they do not contribute much to aggregate price flexibility — for example, they are very transient; they often return to the original price after a sale. ... To me, the key consequence of sticky prices is that demand shocks matter. Demand shocks can come from many places: house prices, fiscal stimulus, animal spirits, and so on. But the key prediction is that prices don't adjust rapidly enough to eliminate the impact of demand shocks."
What are "real rigidities"?
"I think we have a pretty good sense by now of how often prices change. But there's a lot of evidence from the aggregate data suggesting that prices don't respond fully even when they do change. If the pricing decisions of one firm depend on what other firms do, then even when one firm changes its prices, it might adjust only partway. And then the next firm adjusts only partway, and so on. This goes under the heading of real rigidities, and there are many sources of them. One example is intermediate inputs; if you buy a lot of stuff from other firms, then if they haven't yet raised their prices to you, then you don't want to raise your prices, and so on. Another source is basic competition: If your competitors haven't raised their prices, you might not want to raise your prices. The same thing occurs if some price changes are on autopilot, or if the people changing prices aren't fully responding to macro news — this is the core of the sticky information literature. These knock-on effects mean that inflation can still be "sticky" long after all the prices in the economy have adjusted.
"Real rigidities are where it's much more complicated to do an empirical study. You have to ask not only whether the price changed, but whether it responded fully; so you need to have not only the price data, but also to see the shock to form an idea of what the efficient response would be. For that, the difficulty is that you don't often have good cost data. ... The other type of evidence that speaks to this question comes from exchange rate movements. When you have changes in the exchange rate, you have a situation where there's an observable shock to firms' marginal costs, and you can use that to figure out how much prices respond conditional on having adjusted at all. But fundamentally, this is a much more challenging empirical problem."
Sticky Prices and the Great Recession
"I think the Great Recession has actually increased the emphasis in macroeconomics on traditional Keynesian frictions. The shock that led to the Great Recession was probably some combination of financial shocks and housing shocks — but what happened afterward looked very Keynesian. Output and employment fell, as did inflation. And for demand shocks to have a big impact, there have to be some frictions in the adjustment of prices. The models that have been successful in explaining the Great Recession have typically been the ones that have combined nominal frictions with a financial shock of some kind to households or firms.

"One can also see the effects of traditional Keynesian factors in other countries. Jón is from Iceland, which experienced a massive exchange rate devaluation during its crisis. Other countries that were part of the euro, such as Spain, did not. I think this probably mattered a lot; if prices and wages were flexible, the distinction between a fixed and flexible exchange rate wouldn't matter. Another example is Detroit. If Detroit had had a flexible exchange rate with the rest of the United States, a devaluation would have been possible to lower the relative wages of autoworkers, which might have been very helpful. Much of what happened during the Great Recession felt like a textbook example of the consequences of Keynesian frictions."
Bias in China's Inflation Rate?
"There's a lot of skepticism about Chinese official statistics, and we wanted to think about alternative ways of estimating Chinese inflation. We use Chinese consumption data to estimate Engel curves, which give you a relationship between people's income and the fraction of their income that they spend on luxuries versus necessities. All else equal, if Chinese people are spending a lot more of their total food budget on luxuries such as fish, that could tell us that their consumption is growing very rapidly. Holding nominal quantities fixed, higher growth is associated with lower inflation, so we can invert estimates of consumption growth to get the bias in the inflation rate.
"This approach has been applied to many countries, including the United States, and the usual finding is that the inflation estimate you get is lower than official statistics. This is usually attributed to the idea that official statistics don't accurately account for the role of new goods, resulting in lower estimates of inflation.
"But for China we found an interesting pattern. We did find lower estimates of inflation for the late 1990s. But for the last five or 10 years, we find the opposite: Official inflation was understating true inflation, and official estimates of consumption growth were overstating consumption growth. Our estimates suggest that the official statistics are a smoothed version of reality.
"There are a couple of reasons why this could be. One possibility is, of course, tampering. Whenever we present this work to an audience of Chinese economists, they are far more skeptical of the Chinese data than we are. But a second possible interpretation is that it's just very difficult to measure inflation in a country like China where things are changing so quickly."

So you want to be an academic researcher? Nakamura finished her Ph.D. in 2007, so this particular project has been bubbling along for a decade or more.
"One of the things I've been doing since grad school is working on recovering data underlying the CPI from the late 1970s and early 1980s. This is an exciting period for analyzing price dynamics since it incorporates the U.S. Great Inflation and the Volcker disinflation — the only period in recent U.S. history when inflation was really high. In the course of our other research, Jón and I figured out that there were ancient microfilm cartridges at the BLS from the 1970s in old filing cabinets. The last microfilm readers that could read them had literally broken, and they couldn't be read by any modern readers. Moreover, they couldn't be taken out of the BLS because they're confidential.
"So we decided to try to recover these microfilm cartridges. We had an excellent grad student, who became our co-author, who learned a lot about microfilm cartridge readers and found some that could be retrofitted to read these old cartridges. After we scanned in the data, we had to use an optical character recognition program to convert it into machine-readable form. That was very tricky. The first quote we got to do this was over a million dollars, but our grad student ultimately found a company that would do it for a 100th of the cost. This has been quite an odyssey of a project, and there were many times when I thought we might never pull it off. We are now finally getting to analyze the data."