Inflationary Expectations and Price Setting Behavior
Ray C. Fair
This paper tests for the existence of expectational effects in very
disaggregate price equations. Price equations are estimated using monthly
data for each of 40 products. The dynamic specification of the equations is
also tested, including whether the equations should be specified in level
form or in change form. Two expectational hypotheses are used, one in which
expectations of the aggregate price level are a function of the past values
of the price level and one in which expectations are rational. Under the
first hypothesis the lag length is estimated along with the other
parameters, and under the second hypothesis the lead length is estimated
along with the other parameters.
The results strongly support the hypothesis that aggregate price
expectations affect individual pricing decisions. The results do not
discriminate very well between the level and change forms of the price
equation, although there is a slight edge for the level form. The lag and
lead lengths are not estimated precisely, but in most cases the lag length
is less than 30 months and the lead length is less than 5 months.
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