The Price Formation Process in the Albanian Economy: a macro modelling approach

This paper provides the modelling framework of the price formation block in the macro econometric Albanian model (MEAM). MEAM is constructed on neo-Keynesian theoretical principles, implying a vertical long-run aggregate supply curve with aggregate demand factors impacting supply in the short-run. The price formation block is composed of a set of equations that estimate the behaviour of key variables including domestic supply prices, import prices, demand deflators and wages. The primary innovations of this block are the estimation of domestic supply prices based on unit labour costs and of the import prices following a pricing to market approach. Demand deflators, derived on the basis of a homogeneity assumption in domestic supply prices and import prices, determine the final behaviour of prices in the economy.