Time-dependent or State-dependent Pricing? Evidence from Firms' Response to Inflation Shocks

Abstract

This paper proposes a test for distinguishing between time-dependent and state-dependent pricing based on whether the timing of pricing changes is affected by realized or expeted inflation. Using Brazilian data and exploring a large discrepancy between realized and expected inflation surrounding the election of President Lula in 2002-3, we obtain a strong relation between expected inflation and duration of price spells, but little effect of inflation shocks on the frequency of price adjustment. The results thus support models with time-dependent pricing, where the timing for following changes is optimally chosen whenever firms adjust prices.