Deflation/Inflation Dynamics: Analysis based on micro prices

Micro price data show that individual price settings are not time-invariant as presumed in the existing literature. Furthermore, the analysis of autocorrelations shows that interactions of micro prices with leads and lags ignored in the literature play a very important role in explaining the behavior of aggregate price indexes. Price indexes such as the consumer price index (CPI) contain "noises" for the purpose of macroeconomics and monetary policy. The "core" CPI used by central banks, however, is defined merely on common sense and casual observation. We present a new method of extracting information on the systemic changes of aggregate prices based on micro price data. The so-defined "true core price index" is correlated with the number of overtime hours worked, the unemployment rate, and the exchange rate. It is not significantly correlated with money supply. Our analysis also shows that inertia arising from interactions of micro prices more plausibly explains the behavior of aggregate prices than do expectations.