Essays on price-setting models and inflation dynamics

by 1968- Kim, Bae-Geun

This dissertation investigates the empirical validity of several theories on …rms’ price-setting behavior and the dynamics of in‡ation. The dissertation consists of two essays. The …rst essay, Reassessment of the New Keynesian Phillips Curve: Gross vs. Value-Added Price In‡ation, reexamines the new Keynesian Phillips curve based on the distinction between gross price and value-added price in‡ation. It is shown that a standard new Keynesian Phillips curve can be interpreted as describing the behavior of gross price in‡ation and, therefore, it is essential to incorporate intermediate input costs in constructing marginal cost measures. Moreover, from this gross price in‡ation model, the valued-added price in‡ation model is derived explicitly, in which the real price of intermediate inputs plays an important role. The new Keynesian Phillips curve is tested using both in‡ation models. Our results show that (1) the evidence for the new Keynesian Phillips curve is weak for the whole sample period regardless of model speci…cation; (2) in some subsamples, however, especially during high and volatile in‡ation periods, the evidence becomes stronger for the value-added price in‡ation model; and (3) the e¤ects on in‡ation of the real intermediate input prices and the backward-looking behavior of economic agents are substantial. The second essay, The Empirical Relationship between the Markup, Marginal Cost and In‡ation, and Its Implications for Price-Setting Models, studies how in‡ation ii responds di¤erently to di¤erent types of structural shocks. For this purpose, a structural vector autoregression model is constructed that can identify the e¤ects of shocks to the desired markup, technology and aggregate demand. The model shows that (1) in‡ation responds immediately to shocks to the desired markup and technology whereas it displays a hump-shaped response to a demand shock; and (2) the gradual response of in‡ation to a demand shock is caused by an inertial response of marginal cost, not by an inertial response of in‡ation to changes in marginal cost. These empirical …ndings imply that in‡ation itself does not exhibit intrinsic inertia, and thus some sticky price models need not be discarded simply because they fail to generate the hump-shaped response of in‡ation to a demand shock. The analyses suggest that the reason for the gradual response of in‡ation to a demand shock should be found by examining elements that a¤ect production cost. iii To my wife and two daughters, Si-Yeon and Gyu-Yeon iv