DP9702 Time-Varying Business Volatility and the Price Setting of Firms

Author(s): Rüdiger Bachmann, Benjamin Born, Steffen Elstner, Christian Grimme
Publication Date: October 2013
Date Revised: October 2017
Keyword(s): extensive magin, intensive margin, price setting, survey data, time-varying uncertainty/volatility
JEL(s): E30, E31, E32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9702

Does time-varying business uncertainty/volatility affect the price setting of firms and, if so, in what way? To address this question, we estimate from the firm-level micro data of the German ifo Business Climate Survey the impact of idiosyncratic volatility on the extensive margin of the price setting behavior of firms. We find that heightened business uncertainty increases the probability of a price change, which suggests that, for price setting, the volatility effect dominates the 'wait-and-see' effect of uncertainty. In a second step, we use structural VAR models to estimate the effects of time-varying business uncertainty on the intensive pricing margin. We find that higher business uncertainty leads to both an increase in price dispersion and in the average size of absolute price changes which is mainly driven by price decreases. Taken together, our results show that higher business uncertainty causes a rise in both the extensive and intensive margins of price setting.