Title: Price decomposition and asymmetry in various regimes of the economy
Authors: Christos Savva - Cyprus University of Technology (Cyprus)
Demetris Koursaros - Cyprus University of Technology (Cyprus)
Nektarios Michail - Central Bank of Cyprus (Cyprus) [presenting]
Abstract: The price index is decomposed into its two major constituents, markup and marginal cost, via a Markov-switching VAR with fixed transition probabilities. Since the proposed pair of variables has not been extensively analyzed, a theoretical model that derives markups and marginal costs as functions of parameters and shocks is developed to extract identifying restrictions for the VAR. In the empirical exercise, a non-linear representation of GIRFs is obtained, allowing the analysis of 3 different regimes (expansionary, recessionary, supply-shock) with potential sign or size asymmetries in the responses for each regime. We document that due to the opposite movement of markup and marginal cost in all regimes, inflation is less volatile in the recessionary state than in the expansionary state. In addition, we find that larger shocks have a lower (as a percentage of the magnitude of the shock) and less persistent effect on inflation than shocks of a lower magnitude.