On the 1st of January 1999, national currencies were replaced by the euro in eleven European countries. According to some economists, the switch to euro-denominated prices for goods and services (the euro changeover) did not amount to a mere change of the numeraire for current transactions: it could also have generated speculative behaviour, through the implicit coordination of price setters towards higher price equilibria, as a result of money illusion or market imperfections (Fehr and Tyran, 2001; 2007).
Although the possible effects of the euro changeover have been debated in all the countries that switched to euro denominated prices, this has been a particularly controversial issue in Italy, where it has involved consumers claiming that official statistics were not reporting the “true” inflation rate, the authorities and academics as well. Marini et al. (2007), among others, have argued that the combined effect of the introduction of the new currency and the existence of industries with market power could have produced self-fulfilling inflationary expectations leading to discontinuous price jumps totally unrelated to underlying market conditions or fundamentals.
A possible explanation for the difference between perceived and actual inflation is that consumers attach greater weight to price changes in goods and services bought more frequently relative to the so-called ‘big ticket items’, such as durable goods (ECB, 2003; Marini et al., 2007). Official inflation measures reflect instead the price changes faced by hypothetical average consumers, whose consumption basket matches the consumption structure of the economy as a whole. The present paper aims to provide some empirical evidence on whether there exists a changeover effect in the official inflation measure in the specific case of Italy.
In our view, quantifying the possible impact of the changeover effect amounts to identifying a discontinuity in sellers’ pricing behaviour in the changeover period: since price adjustments are costly (Zbaracki et al. 2004; Bergen et al., 2008), a greater number of adjustments should imply an acceleration in inflation dynamics. For this purpose, we estimate a pricing function based on a staggered pricing model that has already been used successfully for the US (Galì and Gertler, 1999, Hall et al. 2000; Bakhsi et al 2007; Janko 2008). Our results document an increase in the average number of price changes, the euro changeover effect being found equal to around 40% of the inflation rate.
