Micro-Price Dynamics in Small Open Economies: Lessons from Ecuador

Abstract

From 1998 to 2003, Ecuador experienced large macroeconomic fluctuations ending with a period of stabilization under a dollarized economy. This dissertation exploits these fluctuations and a novel dataset of micro-prices to examine the relationship between price dynamics and cost structure in three different but equally important dimensions. In the first chapter, I argue that cost-structure plays in an important role in the frequency of price changes. Using a menu-cost model of price adjustment, I show that goods which use more traded inputs in their production are more likely to reprice due to the high variability of import prices relative to non-traded input prices. However, firms that use purely non-traded inputs may still be more likely to reprice than firm that use a mix of inputs because multiple inputs provides a level of diversification in from input price shocks. In the second chapter, the law of one price is examined and Ecuador is shown to have strong mean reversion of internal relative prices. Furthermore, traded and non-traded inputs are not proportionally represented when calculating persistence of the final retail good. Non-traded goods are disproportionally represented in the retail price leading to higher levels of persistence and a weakening of the law of one price at the goods level. The chapter further strengthens the argument that the classical dichotomy holds at the inputs level rather than the final retail price. The last chapter examines exchange-rate pass-through and shows that goods that use more non-traded inputs have lower pass-through. Furthermore, pass-through is related to the distance from the coast.