Ebook Do Menu Costs Make Prices Sticky?
At a currency changeover, firms have to reprint their prices independently of whether or not they want to change prices (menus) and if changing prices is costly, firms will try to make the changeover coincide with a price change. This behavior will be reflected in the data. In the run'up to the changeover, firms will postpone price adjustments and, price changes originally planned for the months after the changeover will be anticipated.
The higher the menu costs, the earlier firms will start postponing. Observing, for example, that an index is constant for six months before the changeover is a strong indication that menu costs can explain a stickiness of at least six months. I have to write mat least because firms might change prices more frequently in the run'up to the changeover than normal.
Figure 1 illustrates the point I want to make. The figure shows restaurant prices in Germany in the years around the changeover. The vertical line denotes the changeover and, just as we would expect when firms anticipate and postpone, the index jumps at the changeover. Note, however, that menu costs can explain a jump only up to the extent that the jump is accompanied by periods of reduced inflation either before or after the changeover. The question is whether we observe a reduction in inflation.
The dashed line indicates trend inflation in the period from 1996 until December 2000. In the 12 months before the changeover, inflation appears to be above trend and only in December 2001 do we observe firms postponing. Continuing this, admittedly simplistic, visual inspection and ignoring that after the changeover there appears to be no sign of firms anticipating, we could argue that menu costs cause a stickiness of one or two months in the restaurant sector.
On average, restaurants keep prices constant for 12 to 24 months which is typical for most services. In the retailing sector, price changes are more frequent. Here, the estimates range from 7 to 11 months. These findings are quite robust across countries. For the U.S., see Nakamura and Steinsson (2007) and the earlier study by Bils and Klenow (2004). Alvarez et al. (2006) and Dhyne et al. (2007) summarize the findings of a number of country studies in Europe. The pricing patterns described by this literature often reveal only limited information about the reason for firmslreluctance to adjust prices more often. In order to shed some light on this issue, Levy, Bergen, Dutta and Venable (1997) estimate the magnitude of menu costs.
The key insight from this study is that menu costs are large enough to be regarded a non'trivial factor in the price'setting decision of firms. The authors estimate that menu costs make up around 0.7% of revenues of U.S. supermarkets (more than $100,000 per year per store or $0.50 per price change). Information about the magnitude of menu costs does, however, not answer the question of whether it is menu costs that cause the stickiness we observe. In survey studies where business people are asked why they do not adjust prices more frequently, menu costs usually receive only relatively low support.
The interesting aspect of the approach taken in this paper is that it reveals directly whether menu costs hinder firms from changing prices more frequently. Using the individual series of Eurostatls HICP data for the years around the Euro changeover, the paper estimates that menu costs can explain a stickiness of around 30 days. The restaurant sector is one of the few examples where we can observe at least some postponing. In most other industries, price setting behavior in the months around the changeover appears no different to other periods. Menu costs do not appear to be a relevant factor in firmslprice setting decisions.
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