Linking Individual and Aggregate Price Changes

Standard macroeconomic forecasting indicators and techniques tend to perform poorly in predicting inflation in the short-run. The present paper shows that microeconomic price data placed in an empirical model rooted in (S,s) pricing theory convey extra information on inflation dynamics. The empirical model designed to capture the deviation between target and actual price, potentially applicable in other contexts where lumpy adjustment is prevalent, is applied to a unique, highly disaggregated panel data set of consumer prices. Fluctuations in the shape of the cross-sectional density of price deviations are found to contribute to short-run inflation in the sample. Asymmetry in the density particularly matters. Idiosyncratic pricing shocks appear to impact on the size rather than the direction of inflation fluctuations. ♣ For many useful comments and suggestions I thank Matthew Shapiro. To an earlier version of this paper, Robert Barsky, Ufuk Demiroglu, Todd Stinebrickner and seminar participants at Michigan, EEA 98 and ESEM 99 provided helpful comments. The usual caveat applies.