In sticky price Old Keynesian or New Keynesian economics, there are two key ideas. First, it is taken as given that some prices are more sticky than others. There is now a large body of empirical work that characterizes the size and frequency of price changes across a wide variety of goods and services. For example, we now know that the price of gasoline changes about once every three weeks, while prices for restaurant items change once every 11 months. Second, in Keynesian models with sticky prices, the quantity of output produced by a firm is demand-determined when the firm's price is stuck.
Suppose then that we accept the standard Keynesian narrative about our current predicament as truth. Correct me if I'm wrong, but the standard narrative is that it is irrelevant how we got into our current state. The relevant feature of the current state is that there is deficient aggregate demand. Deficient demand spreads itself across sectors of the economy and, according to the narrative, can be remedied with stimulative fiscal and monetary policy.
The standard Keynesian narrative, coupled with the sticky price mechanism, is very useful, as it seems that it could generate restrictions on what we should see in the data, with regard to price and quantity variation and dynamics across sectors of the economy. As far as I know no one explores these things, but I could be wrong. It would be helpful if readers who know this literature could direct us to the relevant research.
What am I thinking about here? First, in a Keynesian world that experiences a fall in aggregate demand, relative prices become misaligned. The relative prices of sticky-price goods rise and the relative prices of flexible-price goods fall. Second, employment will fall in the sticky-price sector relative to the flexible-price sector.
Now, my empirical work here is going to be very crude. This is just a blog, after all. Suppose we look only at the 8 primary components of the consumer price index. These are:
1. Food and beverages (weight 14.8%) This includes two very different items, food at home and food away from home (about half-and-half). The purchase of food away from home, is primarily the purchase of a service.
2. Housing (41.5%) This includes not only the cost of shelter, but energy, furniture, and appliances as well.
3. Apparel (3.6%)
4. Transportation (17.3%) This includes gasoline, cars, and public transportation.
5. Medical care (6.6%)
6. Recreation (6.3%) Includes consumer electronics.
7. Education and Communication (6.4%) Computers are included in communication.
8. Other (3.5%) Includes tobacco and miscellaneous services.
Now, we'll take January 2005 as our base period, and look at the time series for the 8 components, displayed in the first chart. Now according to Mike Bryan and Brent Meyer (Mike took his sticky-price index ideas to the Atlanta Fed when he moved), of these 8 items the flexible ones are: food and beverages (food-away-from-home is sticky, but let's put it in this category anyway), transportation (dominated by energy prices), and apparel (they put infants and toddlers in the sticky category, but it just makes it). Bryan and Meyer use Bils and Klenow to categorize prices as flexible or sticky, but Bils and Klenow do not address housing. Since more than half of the housing component is somehow tied to the price of housing, we'll say that housing prices are flexible, since I don't think anyone wants to argue that house prices are sticky. Otherwise, the prices of medical care, education, recreation, and "other" are sticky.
Now, during the recent recession, we certainly see marked changes in the trajectories of the flexible prices. There is a decline of more than 25% in the transportation component, and food prices (which had been increasing) level out, as does the housing component. This all seems more or less consistent with the Keynesian narrative. However, the price of apparel seems to be behaving like a sticky price which is impervious to the recession. Indeed the prices that are supposed to be sticky - medical services, education, recreation - are also impervious. Surely, in the face of this persistent deficient aggregate demand, the sticky prices should ultimately be adjusting downward.
Now, even more puzzling is what happens from early 2009 to the end of the sample. The decline in transportation prices reverses itself (energy prices up again) and food prices pick up again. According to the Keynesian paradigm, this now looks like an increase in aggregate demand, reflected in flexible price increases, and decreases in the relative prices of the sticky-price goods. Of course, this is not the standard Keynesian narrative we hear at all.
Finally, look at where we are in March of 2011 relative to January 2005. If the dominant force over this period was the period of persistent insufficient aggregate demand that began in late 2007, what we should see at the end of 2011 is lower relative prices of flexible price goods and higher relative prices of sticky price goods. The relative price increases were for transportation (flexible), "other" (sticky), medical services (sticky), food (flexible), education (sticky), and housing (flexible). Relative prices declined for recreation (sticky) and apparel (flexible). Thus, the medium-term relative price movements seem to have nothing to do with stickiness/flexibility as it is spelled out in the Keynesian narrative.
The second chart shows some components of establishment employment, chosen to correspond (pretty rough, I know, but the best I could do) to the CPI components. These are medical and education services (sticky), leisure services (sticky), energy (petroleum and coal products - flexible), food (manufacturing - flexible), construction (flexible), durables (flexible), and apparel (flexible). In the chart, the big employment declines are in fact in the flexible price sector. Sectors that are doing relatively well - medical and education services, leisure, energy, and food - are a mix of flexible/sticky price goods and services.
Conclusion: I can't square what I'm seeing in the data with the standard narrative. Can anyone help me out?