Deflation/Inflation Dynamics: Analysis Based on Micro Prices

Abstract

Micro price data shows that individual price settings are not time-invariant as presumed in the existing literature. Furthermore, the analysis of auto-correlations shows that interactions of micro prices with leads and lags ignored in the literature play a very important role in explaining the behavior of aggregate price index. The price index such as CPI contains "noises" for the purpose of macroeconomics and monetary policy. The "core" CPI used by central banks is, however, defined merely on common sense and casual observation. We present a new method of extracting information on the systemic changes of the aggregate price based on micro price data. The "true core price index" so defined is correlated with over-time hours worked, the unemployment rate, and the exchange rate. It is not significantly correlated with money supply. Our analysis also shows that inertia arising from interactions of micro prices more plausibly explains the behavior of aggregate price than expectations.

Keywords: CPI, sticky prices, Hilbert transformation, CPCA

JEL Classification: E31, D12, C40