Refining Stylized Facts from Factor Models of Inflation

Abstract

SUMMARYFactor models of disaggregate inflation indices suggest that sectoral shocks generate the bulk of sectoral inflation variance, but no persistence. Aggregate shocks, by contrast, are the root of sectoral inflation persistence, but have negligible relative variance. We show that simple factor models do not cope well with essential features of price data. In particular, sectoral inflation series are subject to features such as measurement error, sales and item substitutions. In factor models, these blow up the variance of sector-specific shocks, while reducing their persistence. We control for such effects by estimating a refined factor model and find that inflation variance is driven by both aggregate and sectoral shocks. Sectoral shocks, too, generate substantial inflation persistence. Both findings contrast with earlier evidence from factor models, but align well with recent micro evidence. Our results have implications for the foundations of price stickiness, and provide quantitative inputs for calibrating models with sectoral heterogeneity.

The Importance of Hiring Frictions in Business Cycles

“…In the NK benchmark (model iii) instead, the monetary policy shock has real effects, which lead to an increase in employment, investment, output and real wages. 25 Most importantly, real variables respond very differently in the NK model without (model iii, red line) and with (model i, green line) hiring frictions: introducing these frictions virtually eliminates all real effects of monetary policy shocks, so that for all real variables except the shadow value of output (real marginal cost) and wages, the response of the NK model with hiring frictions is indistinguishable from the response of the NC benchmark.…”

“…The impact of a change in the shadow value of output Ψ t on marginal hiring costs is there- 15 We denote in bold variables, which role we want to highlight in the analysis. 16 The term D 1 t is obtained by deriving the wage function in equation (25), and equals:…”

Common and Idiosyncratic Inflation

“…Other papers have used large-dimensional dynamic factor models to study disaggregated prices in the US (e.g., Boivin et al, 2009;Maćkowiak et al, 2009;De Graeve and Walentin, 2015;Conflitti and Luciani, 2019). Among these papers, two are particularly close to ours: Reis and Watson (2010), who estimate an index of equiproportional changes in disaggregated PCE price inflation, which they label "pure" inflation; and Amstad et al (2017), who estimate a measure of underlying inflation on a dataset composed primarily of CPIs, which they call an "Underlying Inflation Gauge" (UIG).…”