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«Chapter 1 Why Study Price Stickiness? Why This Way? Nothing astonishes men so much as common sense and plain dealing. —RALPH WALDO EMERSON The ...»

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The idea behind the theory is that firms have implicit understandings with their regular customers which proscribe price increases in tight markets, presumably in return for stable prices in weak markets. What observable variable can be used to measure the importance, or even the existence, of such implicit agreements? None, we fear—which may be why there has been so little econometric testing to date. But it seems to us that, if such tacit agreements exist, firms ought to know that they do—and should say so when asked.

Our questionnaire therefore “tested” this theory by posing the

following question:

B2(a). Another idea has been suggested for cases in which price increases are not prohibited by explicit contracts. The idea is that firms have implicit understandings with their customers—who expect the firms not to take advantage of the situation by raising prices when the market is tight. Is this idea true in your company?

10 Asking About Prices About two-thirds answered yes. Furthermore, a large majority of those answering yes rated implicit contracts a “moderately important” or “very important” reason why prices adjust slowly in their companies. The theory evidently holds promise in certain sectors of the economy.

But Aren’t Interviews Unreliable?

Economists are disposed to be skeptical that you can learn anything about economic behavior by asking people. Most believe you should not even try. Instead, you should observe what they do in markets (not what they say), model that behavior theoretically, and test the model econometrically.

The litany of objections to interviews is not without merit. Critics argue that responses may be terribly sensitive to the precise wording of the questions. We agree and hence devoted many hours to the form and structure of the questionnaire. While we do not pretend to have achieved perfection (and will, in fact, mention some problems in subsequent chapters), we invite skeptical readers to inspect the full questionnaire that was used in the field. It is included as appendix A of this book.11 Other critics will object that interviewees have no incentive to respond truthfully or thoughtfully, and so may refuse to cooperate or give misleading answers. Where the respondent has reason to conceal the truth or mislead the interviewer, this objection is, to our minds, a show stopper. In such cases, the interview method is simply not a promising mode of inquiry. Thus, for example, interviews may be a poor way to estimate the extent of tax evasion or the prevalence of collusion among businesses. But there are many interesting and important questions about which people have no particular reason to conceal the truth—unless they are pathological liars. In such cases, the interview method might help.

The thoughtfulness problem goes deeper. For example, people may not understand or be able to articulate their own motives or behavior very well. We all know the billiard-ball analogy: A good pool player makes excellent intuitive use of the laws of physics without understanding them intellectually. So if you ask expert players to explain how they shoot so well, they may not give you a coherent answer—and almost certainly will not give an answer Why Study Price Stickiness? 11 that a physicist would mark correct. For this reason, we think, many economists are skeptical that you can learn anything by asking “economic players”—even good ones—about how they play the game.

In part, we agree. We do not, for example, think much is learned by asking corporate executives open-ended questions about the goals of their companies. They may just pick objectives that sound lofty or otherwise appealing. But more pointed questions, posed in plain English, can elicit more useful responses. For example, if you ask skilled billiards players whether they base their shots on the principle that the angle of incidence equals the angle of reflection, they will probably think you strange. But, if you take them to the table and ask about the angles they choose—using elementary physics to tailor your questions—they would probably respond in the affirmative. Closer to home, we should remember that most of our standard data come, in the first instance, from either face-toface interviews or mailed questionnaires filled out by minor functionaries. How else do you think the Labor Department measures unemployment or the Commerce Department estimates Gross Domestic Product (GDP)?12 Thus, while many objections to the interview method have some validity, we should keep them in perspective. Economists above all should evaluate the usefulness of any suggested mode of inquiry— including interviews—by posing the classic question: Relative to what? The imperfect knowledge we pick up from questionnaires should not be compared to some epistemological ideal, but to the imperfect knowledge that nonexperimental scientists can deduce theoretically or glean from econometric investigations.

In doing so, it is important to remember that theory and econometrics also have their limitations, which are often inadequately appreciated. All too often theoretical deductions are untested and/or based on untested premises. Worse yet, either the conclusions or the assumptions may be untestable. Econometric evidence is often equivocal and/or subject to methodological dispute. Results may be fragile owing to small samples or multicollinearity. There may have been “regime changes” during the sample period. Appropriate instruments are scarce or nonexistent in time-series applications. And computers make data mining all too easy. Stacked up against competition of this caliber, the interview method may not 12 Asking About Prices look so bad after all—especially if viewed as a supplement to, rather than a replacement for, more conventional modes of economic inquiry.





In sum, we are more than willing to accept the methodological precept that economists should rely on the standard tools of inquiry—theory and econometrics—where they bear fruit. In cases where people’s observed behavior conflicts with what they say they do, we, like most economists, would stick with the observations.

But we have just argued that conventional research techniques have made virtually no progress in explaining wage-price stickiness.

Might we not, therefore, learn something by opening our eyes and ears and listening to the folks who populate the economies we study, the people who actually do the things we theorize about?

Yes, it is true that physicists and chemists do not ask their subjects why they behave as they do. But, in our zeal to emulate the hard sciences, economists should not misinterpret that lesson. If molecules could talk, would chemists refuse to listen?

A Bird’s Eye View of the Survey Design Details of how the questionnaire was designed and tested, how the sample was selected, and how the interviews were conducted are provided in chapter 3. Here we offer the reader in a hurry a quick summary of the methodology.

Twelve theories of sticky prices—all but one of them culled from the theoretical literature on the microfoundations of macroeconomics—were selected for testing. The selection process was far from random and not entirely objective. First of all, we took it for granted that almost all firms in our economy (excluding farms) are price makers rather than price takers—an assumption amply justied by the survey responses. Second, the selection of theories for testing reflected Blinder’s personal judgments about which of the many theories of price stickiness were most prominent in the academic literature, translatable into plain English, and sensible enough to be explained to business people with a straight face.

These choices are justified, to some extent, in chapter 2.

Each theory so selected was turned into a question for part B of the questionnaire; two examples were offered above. Call Why Study Price Stickiness? 13 these the main questions. (They are numbered B1 through B12 on the questionnaire.) Each main question was followed by up to ten additional questions tailored to the specifics of each theory.

So part B of the questionnaire has twelve sections, one for each theory.13 Part A requests a variety of factual information about the company, such as its size, how often it changes prices, to whom it sells, whether it has formal contracts, and so on. Even economists who are skeptical that we can learn anything of value by asking business executives their opinions on theories may find the answers to these factual questions enlightening. We certainly did.

Selecting the sample was a delicate task. Our philosophy was simple, though its execution was not. We took the goal to be to explain why the GDP deflator moves sluggishly, and hence sought to create a random sample of the GDP. Well, not quite. The sample was actually limited to the private, unregulated, nonfarm, for-profit GDP. The motives for making these exclusions—which together amount to about 29 percent of GDP—are perhaps obvious; if not, they are explained in chapter 3. That chapter also explains our sampling method in detail—namely, how a computerized “dartboard” was created, with each firm assigned a “slice” proportional to its value added.

Once this was done, a random sample of three hundred and thirty firms was drawn, interviews were requested with each, and two hundred agreed to participate.14 The stunningly high response rate of 61 percent already suggests that any nonresponse bias is probably small, but some evidence in support of this point is offered in chapter 3. Interviews were conducted in person, generally in the respondent’s office. A few were done by Blinder personally, but most were carried out by a team of thirteen Princeton graduate students specially selected and trained for the task. Interviews varied in length, depending mainly on how discursive the respondent was, but generally took forty-five to seventy minutes.

Since the probability that any firm would be selected into the sample was proportional to its value added, all averages and distributions reported in this book are unweighted. The weighting was embodied in the probability of being selected into the sample, so any further weighting of the responses would have amounted to double counting.15 14 Asking About Prices Plan of the Book The book is organized into eighteen chapters, but most of them are blissfully short. Chapter 2 reviews the theoretical, empirical, and survey antecedents to this research.

Chapter 3 offers details on the questionnaire, sample selection, and interview procedures, highlighting some problems that are not mentioned in the brief summary above. It also offers some evidence that there were no serious biases from nonresponse, only minor differences in coding across the fourteen interviewers, few significant effects of interview date (the data collection period included a recession), and almost no differences at all by geographical location.

Chapter 4 summarizes the findings from the “factual” part of the questionnaire (part A). We view these findings as answers to a set of fascinating and important questions that simply cannot be addressed with standard data sources. For example, we offer here what we believe to be the first estimates of the fraction of United States GDP sold under written contracts, the fraction sold to repeat customers, the average lag between a change in demand and the corresponding change in price, and so on. Many of the answers are surprising—both to us and to others.16 Chapter 5 provides an overview of the results for the twelve main theories. Which of the theories seem to have the most validity overall and within particular sectors? What do the survey results tell us about specific questions that cut across theories? For example, are prices more sticky downward than upward? Surprisingly, the answer appears to be no. Chapters 6 through 17, most of which are brief, delve into the details of each of the twelve theories. Each chapter explores a theory in detail, gives the survey results on its “popularity,” explores which attributes of a firm help explain its affinity for the theory, and discusses the answers to follow-up questions designed to shed light on the validity, applicability, or other aspects of the theory. Because chapter 6 is the first of these chapters, it also includes some methodological discussion that is relevant for the subsequent chapters.

Finally, chapter 18 quickly sums up, assesses what we have and have not learned, points to some policy implications, and offers the inevitable suggestions for future research.

Why Study Price Stickiness? 15 Chapter Summary This entire book was motivated by a failure—the failure of conventional theoretical and empirical research tools to answer a question

of overwhelming importance for macroeconomic theory and policy:

Why are prices sticky? One important impediment to progress, we suggest, is that many of the competing theories are epistemologically empty, or nearly so. They may predict nothing other than that prices should move more slowly than some unknown Walrasian norm. Or they may be based on variables which are either unmeasurable in principle or unmeasured in practice.

Is there a way out of this methodological box? Some economists, perhaps most, would answer no. But, since each theory is based on a chain of reasoning that allegedly takes place inside a decisionmaker’s head, we suggest that an interview approach may hold promise. To be sure, there are many hazards in trying to learn about how economies work by asking participants. But skeptics who raise these (valid) objections to interviews often forget about the many hazards that plague conventional econometric and theoretical research. A pragmatic attitude, not methodological purity, is called for. And since the interview method is virtually uncharted territory, an initial exploration seemed worthwhile—and was made. This

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