International Price Dispersion in State-Dependent Pricing Models: Theory and Evidence

Virgiliu Midrigan

No 206, 2004 Meeting Papers from Society for Economic Dynamics

Abstract: Studies of disaggregated price data document a robust, positive relationship between nominal exchange rate (NER) volatility and the variability of relative prices for cities separated by national borders. This relationship is interpreted as evidence of sticky prices. This paper shows that a state-dependent sticky price model implies a U-shaped rather than monotonic relationship between relative price variability and nominal exchange rate volatility. In relatively calm environments, higher NER volatility lowers relative price variability as firms adjust more frequently. Only when exchange rate volatility is sufficiently large and firms adjust almost instantaneously, does higher nominal exchange rate volatility cause more variable relative prices. We provide empirical support for this result using a novel dataset of homogeneous goods prices collected in Eastern Europe during 1998-2002. Relative price variability is increasing in nominal exchange rate volatility during the years of the Russian financial crisis, but is falling in NER in the calmer years that follow

Keywords: exchange rates; menu costs; relative price variability (search for similar items in EconPapers)
JEL-codes: E30 F41 (search for similar items in EconPapers)
Date: 2004
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed004:206

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