Temi di discussione. del Servizio Studi

Transcription

1 Temi di discussione del Servizio Sudi Is here a cos channel of moneary policy ransmission? An invesigaion ino he pricing behaviour of 2,000 firms by Eugenio Gaioi and Alessandro Secchi Number December 2004

2 The purpose of he Temi di discussione series is o promoe he circulaion of working papers prepared wihin he Bank of Ialy or presened in Bank seminars by ouside economiss wih he aim of simulaing commens and suggesions. The views expressed in he aricles are hose of he auhors and do no involve he responsibiliy of he Bank. Ediorial Board: STEFANO SIVIERO, EMILIA BONACCORSI DI PATTI, FABIO BUSETTI, ANDREA LAMORGESE, MONICA PAIELLA, FRANCESCO PATERNÒ, MARCELLO PERICOLI, ALFONSO ROSOLIA, STEFANIA ZOTTERI, RAFFAELA BISCEGLIA (Ediorial Assisan).

3 IS THERE A COST CHANNEL OF MONETARY POLICY TRANSMISSION? AN INVESTIGATION INTO THE PRICING BEHAVIOUR OF 2,000 FIRMS by Eugenio Gaioi * and Alessandro Secchi * Absrac The paper explois a unique panel, covering some 2,000 Ialian manufacuring firms and 14 years of daa on individual prices and individual ineres raes paid on several ypes of deb, o address he quesion of he exisence of a channel of ransmission of moneary policy operaing hrough he effec of ineres expenses on he marginal cos of producion. I has been argued ha his mechanism may explain he dimension of he real effecs of moneary policy, give a raionale for he posiive shor-run response of prices o rae increases (he price puzzle ) and call for a more gradual moneary policy response o shocks. We find robus evidence in favour of he presence of a cos channel of moneary policy ransmission, proporional o he amoun of working capial held by each firm. The channel is large enough o have non-rivial moneary policy implicaions. JEL classificaion: E52, E31. Keywords: moneary ransmission, cos channel, working capial. Conens 1. Inroducion The effecs of moneary policy on producion coss Implicaions Exising evidence A price equaion wih a cos channel The daa A panel esimaion of he cos channel Is he cos channel effec economically relevan? Conclusions Tables and figures...27 Appendix I Appendix II References * Bank of Ialy, Economic Research Deparmen.

4 7 1. Inroducion 1 A growing lieraure has addressed he possibiliy ha moneary policy acions do no only affec aggregae demand, bu also exer an influence on economic variables hrough he supply side; namely, hey influence firms ineres expenses on working capial and, as a consequence, marginal coss of producion and oupu prices. The implicaions of such a conjecure are far reaching. The mos apparen is ha in he shor run an increase in ineres raes may cause prices o rise, raher han o fall. The possibiliy ha moneary policy shares some of he feaures of a supply shock would also help o explain he large and persisen effecs of moneary policy on he real economy. Las bu no leas, he exisence of his effec may also have imporan consequences in he design of opimal policies, as i is likely o imply a worsening of he shor-run oupu-inflaion rade-off and o call for a more gradual sabilizaion of inflaionary shocks. However, empirical evidence in favour of his hypohesis is no abundan and remains conroversial. Virually all of i is based on aggregae - someimes secoral - daa and, in paricular, on he idenificaion of a shor-erm posiive response of aggregae prices o ineres rae shocks. I is well known ha macro-evidence regarding he effecs of moneary shocks is subjec o subsanial idenificaion and specificaion problems and, consequenly, o considerable uncerainy of inerpreaion. The issue, herefore, is no ye seled. This paper s conribuion is o exploi he rich informaion from a unique micro-daase of Ialian manufacuring firms, covering 14 years and abou 2000 firms, which, mos noably, includes firm-specific daa on changes in oupu prices and on he ineres rae paid on deb. The availabiliy of disaggregaed informaion helps us o make imporan advances wih respec o he exising empirical lieraure, avoiding he idenificaion problems ypical 1 The auhors are indebed o Fabio Canova, Francesco Lippi and Domenico Marchei for heir commens and discussions. We are also graeful o paricipans in seminars a he Bank of Ialy, a he 44h meeing of he Socieà Ialiana degli Economisi and a he Universiy of Treno. The usual disclaimer applies. The opinions expressed in his paper are hose of he auhors and in no way involve he responsibiliy of he Bank of Ialy. E- mail: eugenio.gaioi@bancadialia.i, alessandro.secchi@bancadialia.i.

5 8 of ime-series esimaes. By exploiing cross-secion variabiliy in oupu prices and ineres expenses we are able o disenangle firm-specific cos channel effecs from demand effecs, which are aggregae in naure. Moreover, he availabiliy of firm-level informaion on hose variables which affec he exisence of a cos channel enables us o consruc supplemenary and sharper ess for he exisence of he cos channel. Our analysis, based on firm-level daa, idenifies a significan effec of ineres expenses on firms prices. The esablished hypohesis ha his effec is linked o he role of working capial in he producion process of he firm, i. e. o a emporal mismach beween facor paymens and sales receips (Hicks, 1979, Chrisiano, Eichenbaum and Evans, 1997 and Barh and Ramey, 2001), canno be rejeced. On he basis of he properies of sandard heoreical macro-models which feaure a cos channel, we judge he size of his supply-side effec o be large enough o warran careful consideraion in he design of moneary policy. The paper is organized as follows. Secion 2 reviews he lieraure on he supply effecs of moneary policy and ses ou he specific conribuion of his paper. Secion 3 derives a price equaion in which he ineres rae is allowed o affec he marginal cos of producing oupu. This equaion forms he basic specificaion o be used in he esimaion sage. Secion 4 presens he main feaures of our daase. The main empirical resuls and some exensions are repored in secions 5 and 6. Secion 7 concludes. 2. The effecs of moneary policy on producion coss 2.1 Implicaions The idea ha ineres expenses should be reaed as a cos of producion is a longsanding one. The argumen ha a decrease in ineres raes deermines a reducion in prices via lower coss of producion was already advanced in 1844 by Thomas Tooke, leading scholar of he banking school. 2 Hicks (1979) argues ha he shor-erm ineres rae should be regarded as he price of a paricular facor of producion (in addiion o capial and labour), which he labels waiing ime or ineremporal swich in oupu. 2 See he survey by Ginzburg and Simonazzi (1997).

6 9 Seelig (1974) repors a famous version of he view ha he ineres rae affecs coss of producion, expressed by US congressman Wrigh Paman, chairman of he Join Economic Commiee, who in March 1970 argued ha raising ineres raes o figh inflaion was like hrowing gasoline on fire. Goodhar (1986, p. 96) recouns he opinion of Briish businessmen, who sill end o regard ineres raes as a cos and look o esablish a price rise in response o increased ineres raes. More recenly, Evans (2001) quoes anecdoal informaion colleced by Federal Reserve saff in imes of rising ineres raes, abou he passing over of increasing invenory coss o prices. Similar argumens were also prominen in he debae on moneary policy and inflaion in Ialy in he 1970s. Andreaa (1973, p. 348), quoing Gran (1972), advances he argumen ha a credi resricion can conribue o inflaion when i bears on he supply side, limiing he financing of working capial. Valli (1979, p. 146) argues ha an increase in ineres raes inroduces inflaionary pressures in he economy by increasing he firms cos of capial. Barh and Ramey (2001) revive he argumen ha moneary policy may operae in he shor run hrough a cos channel (while in he longer run he demand channel dominaes, consisenly wih money neuraliy). They argue ha moneary policy shocks affec he shorrun producive capaciy of he economy by shifing boh he demand and supply funcions in he same direcion, and ha his mechanism may help o explain hree empirical regulariies no well accouned for by sandard heories: he degree of amplificaion and persisence of he real effecs of moneary shocks, he empirical finding ha he price level rises in he shor run in response o a moneary ighening ( price puzzle ) and he fac ha, in he shor run, he responses of he main macroeconomic variables o a moneary shock are more similar o hose due o a echnology shock han o a demand shock. 3 According o Barh and Ramey, he cos channel is based on an acive role of ne working capial (invenories, plus rade receivables, less rade payables) in he producion process and on he fac ha variaions in ineres rae and credi condiions aler firms shorrun abiliy o produce final oupu by invesing in ne working capial. This effec may be modeled by direcly assuming ha invenories or working capial ener he producion 3 They presen evidence showing ha produciviy and real wages fall afer an adverse produciviy shock or a resricive moneary shock; in conras, hey rise afer a negaive demand shock.

7 10 funcion (Ramey, 1989 and Ramey, 1992) wih he ineres rae being he price of such a facor. Alernaively, a emporal mismach beween facor paymens and sales receips may be explicily modeled: Chrisiano, Eichenbaum and Evans (1997) show ha, in a model where oupu is produced only hrough labour and where he purchase of producion facors mus be financed hrough borrowing, he marginal cos of labour is equal o he wage imes he gross nominal ineres rae. 4 Ineres raes affec producion coss also in he models by Farmer (1984) and Chrisiano and Eichenbaum (1992). Anoher srand of lieraure links he exisence of a credi channel of moneary ransmission o supply-side effecs of moneary policy, arguing ha, due o he laer, igher moneary policy may be inflaionary (Sigliz and Greenwald, 2003, p.155). 5 The exisence of a cos channel can aler he opimal course of moneary policy in he face of various shocks, possibly in a subsanial way. Ravenna and Walsh (2003) derive a cos channel effec in a new-keynesian framework based on opimizing behaviour, again assuming ha wages are paid in advance. They show ha, under his assumpion, an inflaion-oupu rade-off arises even afer produciviy or demand disurbances and conclude claiming ha opimal policy calls for more gradualism in he sabilizaion of he inflaion rae. Under he assumpion ha all variable coss of producion are paid one quarer in advance, he opimal policy response o an adverse shock on prices needs o be much more gradual. I can be shown ha in heir model, in he case of a cos-push shock i may even be an ineres rae easing, as he cenral bank can in par offse he adverse cos-push shock by decreasing raes, hus relieving firms from ineres expenses on heir working capial. 6 However, he acual relevance of his conclusion crucially depends on he quaniaive magniude of he effec of ineres raes on marginal coss. 4 A differen srand of lieraure concenraes on he effec of igher liquidiy consrains on prices hrough mark-ups, raher han hrough marginal coss (Chevalier and Scharfsein, 1996; on Ialian firms, Boasso, Galeoi and Sembenelli, 1997)). Barh and Ramey (2002) sress he similariies wih he cos channel hypohesis. 5 Fiorenini and Tamborini (2001) also emphasize he poenial connecion beween credi condiions and firms producion aciviy as he missing link in he credi channel lieraure. 6 The poin is illusraed in Appendix I.

8 Exising evidence Even if he cos channel is becoming a common building block in general equilibrium macro models, he empirical evidence regarding is exisence and relevance is sill limied and mainly based on he idenificaion of a shor-run posiive effec of ineres rae increases on aggregae, or secoral, price levels. Seelig (1974), based on wo and hree-digi indusry daa and on he assumpion of mark-up pricing above average uni coss, argued ha in he 1950s and he 1960s he impac of ineres rae changes on prices was fairly negligible. More recenly, Barh and Ramey (2001) provide evidence in favour of he exisence of a cos channel in he US over he las fory years, showing ha afer a resricive moneary policy shock he price/wage raio increases (and produciviy decreases) in a vecor auo-regression. The laer finding is sronger in hose (wo-digi) indusries ha feaure larger ineres expendiures as a share of sales. Ravenna and Walsh (2003) esimae a sylized general equilibrium model for he US and find ha he cos channel exers a saisically and economically significan role in deermining price and oupu dynamics: a one percen increase in (quarer-on-quarer) ineres raes affec he marginal cos of producion by abou 1 poin. However, in a similar seing Rabanal (2003) obains a much smaller value of he cos channel coefficien. Ye, here are a few shorcomings ha affec more or less direcly he resuls presened so far in he lieraure. I has been repeaedly shown ha he empirical finding of a posiive correlaion beween ineres rae and prices, known as he price puzzle, is no necessarily relaed o a srucural relaionship bu could simply reflec he cenral bank s reacion funcion (Sims, 1992) and he omission of some relevan variable from he analyical framework (Chrisiano, Eichenbaum and Evans, 1994 and Balke and Emery, 1994); as a consequence, he main empirical building block of he cos channel conjecure ress on shaky ground. 7 More generally, he need o disenangle he effecs of ineres raes on he supply side from hose on he demand side and he need o ake ino accoun he effec of oupu and prices on ineres raes via he reacion funcion poses complex idenificaion problems, which may also affec he esimaion of GE models, so ha esimaes based on aggregaed daa are likely o provide inconclusive evidence of he magniude of he cos channel effec.

9 12 This seems o be confirmed by he conflicing evidence repored by various auhors. Even if in principle one could consruc empirical frameworks ha would allow for cleaner ess of he exisence of he cos channel, in mos of he cases hese should be based on he use of variables ha, a he aggregae level, are eiher no available or lack he degree of ineremporal variabiliy needed o idenify cos channel effecs. Working capial is one example of such variables. The sraegy we adop o ge rid of he shorcomings ha plague ime-series esimaes is based on he observaion ha he main difference beween he demand channel and he cos channel is ha he former is inrinsically aggregae (or secoral) while he laer, being based on he amoun of working capial owned by each firm and on is specific ineres rae, is an individual effec. This implies ha a direc way o search for an effec of ineres rae changes on firms pricing policies is o inspec individual oupu price responses o ineres rae changes once all aggregae effecs (including radiional moneary policy ransmission hrough demand) and variaions in maerial and labour coss are conrolled away hrough, respecively, appropriae dummies and firm-level informaion on variaions in inpu coss. This approach has so far been consrained by daa limiaions and in paricular by lack of informaion on firm-level prices and ineres raes. We exploi he possibiliies offered by he availabiliy of a unique firm-level daase (discussed in deail in Secion 4) which includes firm-specific informaion on annual changes in he price of oupu, as well as on ineres raes and on he imporance of working capial. The availabiliy of firm-level daa is paricularly appealing for differen reasons. Firs, i allows esing for he exisence of a posiive relaionship beween individual changes in ineres raes and individual changes in oupu prices which, once aggregae effecs are conrolled for, migh be inerpreed as a condiion for he exisence of he cos channel. Second, aking advanage of firm-level informaion on boh ineres raes and on he weigh of working capial in he producion process, we are able o es for he relevance of he deerminans of he cos channel discussed by Barh and Ramey (2001). Finally, furher informaion available in our daase, such as he frequency of price revisions by individual firms, allows us o perform several robusness ess of our conclusions. 7 See also Gilchris (2001) and Evans (2001).

10 13 Our sraegy consiss of wo seps. Firs we derive a firm-level price equaion ha allows for a direc effec of ineres raes on prices. Then we esimae a se of alernaive empirical specificaions of his equaion o es for he exisence of he cos channel. 3. A price equaion wih a cos channel We derive a sandard price equaion in he spiri of Bils and Chang (2000), assuming a producion echnology ha uses labour, capial and maerial inpus. Oupu prices are se in a framework of monopolisic compeiion, as a mark-up over marginal coss, while he firm behaves as a price-aker on he facor marke. Maerial inpus are included o allow for he role of working capial: we impose ha a fixed fracion of hese inpus mus be held as invenories and financed. We also assume ha a fracion of labour inpus mus be paid in advance and exernally financed. Oupu is produced according o: 8 (1) y = A M N K where A reflecs echnology, M is maerial inpu, K is capial, N is labour. A cos channel is inroduced by assuming ha labour and maerial inpus mus be paid in advance and have o be financed a an ineres rae equal o r. More specifically, we assume ha in each producion period he firm mus hold a fixed proporion k M of maerial inpus as working capial (invenories less ne commercial deb) 9 and pay a fixed proporion, k N, of he wage bill before receiving he labour services. The laer assumpion is included 8 The price equaion derived in his secion does no require consan reurn o scale (he assumpion of marke power ensures ha second order condiions are me anyway). We adop a Cobb-Douglas specificaion for he sake of simpliciy; similar resuls could be obained wih more general funcional forms, as in Bils and Chang (2000), or even assuming ha capial is a fixed facor in he shor run, as in Chrisiano, Eichenbaum and Evans (1997). 9 The assumpion of a fixed k M is made for he sake of analyical simpliciy. I could alernaively be assumed ha invenories direcly ener he producion funcion, implying ha heir demand is inversely relaed o ineres raes. I can be shown ha his would no subsanially aler he marginal cos equaion (4) in a neighbourhood of equilibrium.

11 14 because i is widely used in he heoreical lieraure; however, i is no essenial, as i can be dropped wihou affecing he overall resuls. 10 Denoing he prices of maerial inpus, labour and capial respecively as v, w and c, and he ineres rae paid o finance working capial and anicipaed wages as r, oal coss are given by: (2) C = vm (1 km r ) w N (1 knr ) c K Building on firs order condiions of he cos minimizaion problem, and defining γ=/(), he log-change in he marginal cos (a do above a variable indicaes logvariaions) is equal o: 11 (3) MC= ( 1 γ ) w γv [ y ( γm (1 γ ) N )] h r (1 γ ) k N r where we defined h γ k M and simplified ou he user cos of capial c. 12 The price equaion is hen obained by equaing he change in price o he change in marginal cos and change in mark-up. 13 The final price equaion can be wrien in wo equivalen ways: (4) P = µ ( 1 γ ) w γv [ y γm (1 γ ) N ] h r (1 γ ) k N r (5) P = µ ( 1 γ ) ULC γ UMC h r (1 γ ) k N r Equaion (4) includes on he righ-hand side he change in he ineres rae, which eners in wo ineracion erms: muliplied by he working capial/oal coss raio(h) and muliplied by a erm proporional o he value added/oal coss raio(1-γ). Moreover, he 10 The assumpion by Chrisiano, Eichenbaum and Evans (1997) ha labour coss are anicipaed for he whole producion period corresponds, in our noaion, o k N =1. 11 See Appendix II for deails on he derivaion. The change in marginal cos can also be wrien as: MC = (1 γ ) w γv TFP ( ) 1 ( N K ) h r (1 γ ) k This formulaion, akin o he one used by Bils and Chang (2000), is wrien in erms of he change in oal facor produciviy (TFP) and a measure of he labour/capial raio. For such a formulaion o be empirically operaional, an esimae of K is needed, whose derivaion would go beyond he scope of his paper. 12 Simplifying away c is convenien since direc measures of his variable are problemaic and no cenral o he purpose of his paper. In (3), movemens in he user cos of capial indirecly affec marginal cos by inducing movemens in labour produciviy. 13 The implici assumpion is ha firms adjus heir price each period, which is no compleely unrealisic N r

12 15 equaion also includes he change in inpu prices and wages, as well as, in square brackes, a measure of he change in produciviy, which is specified as a weighed average of he change in oupu per worker and he change in oupu per uni of inpu. The role of his erm is hreefold: 14 i capures he effec on prices of exogenous changes in produciviy due o he erm A, i measures he effec of movemens in he user cos of capial c (which induce changes in he labour/capial and inpu/capial raios) and, in he case of non-consan reurns o scale, i also capures scale effecs. Equaion (5) is expressed direcly in erms of he change in uni coss (uni maerial inpu cos, ULC y w N ), muliplied by he relevan shares. UMC y v M, and uni labour coss, From firs order condiions, he parameer γ equals he share of maerial inpus coss over oal coss: γ=(v M (1k m r ))/C ; consequenly, he parameer h is approximaely equal o he raio beween working capial and oal coss C. Equaions (4) and (5) are mapped in wo empirical specificaions. The firs one is: (6) P = µ a [( 1 γ ) w ] a [ γ v ] a [ y γ M (1 γ ) N ] a [ h r ] a [(1 γ r ] a [ CU ] i, 1 i s, 2 i s, 3 i, i i, i i, 4 i i, 5 i ) where sub-indexes s and i denoe ha a variable is measured, respecively, a a secoral or i, 6 i, a an individual level. In equaion (6), is he change in oupu price for firm i in period ; P i, µ s, is he ime-varying change in he mark-up, measured by he inclusion of ime-secor dummies, which also capures all aggregae effecs on prices; ( 1 γ ) i w s, is he change in conracual wages in branch s (o which he firm belongs), imes he value added/oal coss raio for firm i; similarly, γ iv s, is he change in inpu prices in branch s imes he share of maerial inpu over oal coss in firm i; ( γ M ( 1 γ N ) y i, i i, i ) i, is a measure of produciviy change; h i r i, is he change in he firm-specific ineres rae, imes he firm-specific variable h i, which is measured as he fracion of ne working capial over oal coss; (1- γ i ) r i, ineracs he change in he ineres rae wih he share of value added in oal coss; his erm is based on he assumpion ha he fracion of labour cos which have o be given he annual frequency of our daa. The issue is addressed in more deail in secion The erm in square brackes may be wrien as ( ) [ A ( c w ) ( 1) y ].

13 16 anicipaed (k N ) is consan across firms. CU i, is a measure of capaciy uilizaion in firm i a ime. The laer erm, which does no appear in (4), is included o conrol for firm-specific changes in mark-ups. 15 We expec he esimaed parameers a 1 - a 4 o be equal o 1, as suggesed by equaion (4), and a 5 and a 6 o be posiive. We are in paricular ineresed in he sign and size of coefficiens a 4 and a 5, which measure he cos channel effec. The second specificaion is: µ (7) Pi, = b1 ( 1 γ i) ULCi, ) b2 ( γ iumci, ) b3 ( hi ri, ) b4 [(1 γ i) ri, ] b5cu i, where (1-γ i )ULC i, is he change in firm i s uni labour cos, imes he share of value added over oal cos in he same firm and γ i UMC i, is he change in firm i s uni maerial inpu cos imes he share of maerial inpu cos over oal cos. The oher erms are he same as in (6). We expec coefficiens b 1 - b 3 o be equal o one, as in equaion (5), and b 4 and b 5 o be posiive. Again, we are paricularly ineresed in he sign and size of coefficiens b 3 and b The daa The panel is obained by combining informaion from hree daases: he Survey of Invesmen in Manufacuring (SIM, Indagine sugli invesimeni delle imprese indusriali ), he Company Accouns Daa Service (CADS, Cenrale dei bilanci ) and he Ialian Credi Regiser (CR, Cenrale dei rischi ); he laer source is only used in some of he regressions. The SIM daabase includes individual informaion on Ialian manufacuring firms since Daa are colleced a he beginning of each year by inerviewing a sraified sample 16 of beween 500 and 1000 firms wih more han 50 employees. The firs par of he survey 15 Domowiz, Hubbard and Peersen (1988) poin ou ha here is a srong posiive relaionship beween capaciy uilizaion and marke power. Marchei (2002) provides evidence in favour of his posiive relaionship for Ialian manufacuring firms. The inclusion of capaciy uilizaion in he esimaed equaions can also represen a shor-run, ransiory effec of idle capaciy on he pricing behaviour of he firm (Ecksein and Fromm, 1968). In our esimaes, he resuls proved o be robus o he inclusion or exclusion of his variable. 16 The sample is sraified according o hree crieria: secor, size and geographical locaion. Wih regard o he firs crieria he wo digis ATECO91 classificaion of he Naional Insiue of Saisics (Isa) is adoped. Size is proxied by he number of employees (four classes are evaluaed: 50-99, , , 1000). Locaion refers o a regional (19) disaggregaion. The sraificaion mehodology adoped (opimal allocaion o sraa) implies ha in SIM larger firms and firms locaed in he souh of Ialy are somehow over-

14 17 includes qualiaive and quaniaive informaion on he corporae srucure of he firm, employmen, invesmen, curren producion and echnical capaciy. The second par covers specific opics ha change year by year. An inense process of daa revision is carried ou by officials of he Bank of Ialy. A special effor has been made o keep informaion as closely comparable as possible in subsequen years. Sill, he daase may be affeced by some adverse self-selecion bias since firms belonging o SIM are inerviewed on a volunary basis. For our purpose, a major advanage of SIM is he fac ha i conains informaion on a number of variables ha are no usually available. Very imporanly, since 1988 i includes he average percenage change in oupu prices, which is one of he core variables in our analysis. The CADS daabase conains deailed balance-shee and profi and loss informaion on Ialian non-financial firms. Daa are colleced by a consorium, which includes he Bank of Ialy and all major Ialian commercial banks ineresed in pooling informaion abou heir cliens. Time series saring in 1982 are available in elecronic forma; he sample is currenly composed of (around) 50,000 firms. A major advanage of CADS is ha daa undergo an accurae process of reclassificaion which ensures a good degree of comparabiliy boh across firms and ime. However, he daabase does no include firms ha have credi lines for an amoun less han (abou) 80,000 euros, ha do no use heir credi lines or ha are insolven, which may inroduce an upward bias in he average crediworhiness of he firms belonging o CADS. The Ialian Credi Regiser (CR) is a daabase, housed a he Bank of Ialy, which conains exensive informaion on loan conracs graned by Ialian banks. All banks repor informaion on credi graned and uilized for all loans in excess of a minimum hreshold; 17 a subse of 80 banks also repor he ineres rae charged o individual borrowers, for differen ypes of loans: commercial loans, personal loans, credi lines, foreign credi operaions, collaeralized loans, medium and long-erm loans. Due o changes in he degree of coverage, we are currenly in a posiion only o exploi CR for a shorer ime span, saring in represened. 17 The hreshold was se a 80 million lire (41,300 euro) unil 1995 and a 150 million lire hereafer. I is currenly se a 75,000 euro.

15 18 During he las wo decades, SIM, CADS and CR have been exensively used o invesigae a large number of disparae opics. Only in he las few years have some auhors sared exploiing he possibiliies provided by heir join use. Guiso and Parigi (1999) merge daa on capial sock, income and cash flow (CADS) wih daa on effecive and planned invesmen and on expeced demand (SIM) o invesigae he effecs of uncerainy on he invesmen decision of a sample of Ialian manufacuring firms. Marchei and Nucci (2001) use daa on employmen and hours, labour compensaion, invesmen and capial sock (SIM) and use hem ogeher wih informaion on sales, invenory change, purchases of inermediae goods (CADS) o obain a measure of echnological change ha is no affeced by any source of procyclical produciviy. Marchei and Nucci (2002) merge he wo daases o obain deailed saisics on he ypical frequency of price revision of a sample of Ialian manufacuring firms and o invesigae wheher differen degrees of price sickiness affec how a echnological shock influences he use of he labour inpu in he producion process. Guiso, Kashyap, Panea e Terlizzese (2002) use daa from CADS and CR o invesigae how esimaes of he ineres sensiiviy of invesmen depend on alernaive measures of he marginal financing coss of he firm. Informaion on individual price changes only exiss in SIM since The complee sample of SIM over he period , afer excluding a few firms ha do no belong o he manufacuring secor, includes 2724 firms (14,827observaions). Ariion relaed o he merging wih CADS and missing values reduce he iniial sample o a se of 2192 firms (9751 observaions). 18 Our sample is fairly represenaive of firms wih more han 50 employees according o he geographical and o he secoral composiion; however, i is slighly biased oward larger firms (Tables 2 o 4). Table 5 presens some basic saisics on he variables ha are used in he empirical analysis. The dependen variable, he firm-level percenage change in he price of oupu ( ), is drawn from SIM, based on a specific quesion. 19 The aggregae behaviour of his variable P i, 18 In Table 1 we repor he number of observaions in each of he years of he final sample. 19 Firms are asked o repor he percenage change in he average price of goods sold, ogeher wih he nominal change in sales. To check he consisency of he responses, a conrol quesion asks o repor he

16 19 racks closely is macro equivalen: he correlaion beween is annual sample mean and he annual change in oupu prices in manufacuring (Isa) is around 0.9 (Figure 1). A firs measure of he firm-level ineres rae (r CR i,,) is obained direcly from bank daa, as he firm-specific lending rae on commercial borrowing and commercial paper discouned (CR), measured a end-year. This is an almos ideal variable for our purposes, as i maches he appropriae ype of borrowing o finance working capial and i is measured quie precisely in he daase. However, i is available over a shorer ime inerval han he res of he sample (since 1989, or 1990 afer aking firs differences). 20 As a robusness check, and o gain degrees of freedom, a second measure of he ineres rae (r CA i,) is consruced by dividing oal ineres expenses by oal financial deb (CADS). This measure has he advanage of being available for a larger number of firms and for a longer ime horizon. However, being compued ex pos from balance shee daa which aggregae a large number of liabiliies of he firm, i is likely o be subjec o measuremen errors; moreover, unlike he previous measure, i aggregaes he ineres rae paid on all ypes of borrowing. A hird measure is he average policy ineres rae (r P ), i. e. he average annual Bank of Ialy repo rae and he rae on ECB main refinancing operaions since This measure is no firm-specific; he cross-secional variabiliy of he variable included in he regression is solely due o he ineracion erms. When using his measure of he ineres rae, he advanages of he micro-approach may be somehow diminished, alhough we may direcly answer he quesion of he effecs of policy moves on firms pricing behaviour. The hree measures are used alernaively o check robusness of he resuls. Through ime, hey behave consisenly wih each oher (Figure 2). Ne working capial is consruced using daa from CADS and i is defined, following Barh and Ramey (2001), as he value of invenories, plus commercial credi, less commercial deb. To obain he raio h i, we divide ne working capial by oal operaing variaion in sales in real erms. 20 To conrol for ouliers, we firs deleed observaions below he 5 h and above he 95 h perceniles of he disribuion of he ineres rae level; hen applied he correcion again o he firs differences of resuling series ( r i, ). Exreme observaions were similarly omied in all firm-level variables.

17 20 coss, which are available in CADS 21 ; firm averages are hen aken across he whole period. Noe ha all resuls presened in his paper are fairly robus o he use of alernaive definiions of his raio (e. g. using oal sales as he denominaor). The mean h (across firms and ime) is equal o 0.33, i. e. firms keep four monhs of annual coss in he form of invenories. 22 Luckily for our research sraegy, h i displays a large cross-secional variabiliy, ranging from slighly below zero o 1.09 (Figure 3), hus effecively discriminaing beween firms wih differen working capial requiremens. As for he remaining variables, he variable ( γ i ) w s, 1 is consruced by muliplying wo-digi secoral changes in conracual wages (Isa) by (1-γ i ), wih γ i se equal o he firm-specific average raio beween inpu and service coss and oal coss (CADS) (he sample mean of γ is around 0.76); similarly, he variable γ iv s, is consruced by muliplying wo-digi secoral log-changes in inpu prices (Isa) by γ i. The variable 1 γ L ) is consruced by subracing he log-change in real sales (SIM) from he ( ( i ) U C i, nominal log-change in labour coss (CADS) and muliplying i by ( 1 γ i ); similarly, he variable γ M is consruced by subracing he log-change in real sales (source: SIM) i U C i, from he log-change in maerial coss (CADS) and muliplying i by γ i. The variable, 1 ( y i γ imi, ( γ i ) Ni, ) is consruced by subracing from he log-change in real sales (source: SIM) he log-change in maerial inpu a consan prices (nominal oal inpu cos deflaed wih secoral inpu prices) and he log-change of labour inpu (change in average number of employees, source: CADS), appropriaely weighed. Finally, he firm-level rae of capaciy uilizaion (CU i, ) is available in SIM as he answer o a specific quesion ("wha is he raio beween acual producion and he level of producion which would be possible fully using he available capial goods wihou changing labour inpus?"). The correlaion beween he annual across-firm mean of his variable and a sandard macro-measure of 21 In CADS, operaing coss are defined as he sum of purchases of maerials, inermediae and services, labour coss, ineres expenses and depreciaion allowances. In all cases when daa on commercial credi and debi were missing, he raio was compued as he invenory/operaing coss raio (he esimaes were no significanly affeced). 22 The average raio o oal sales is only marginally smaller and equal o 0.32.

18 21 capaciy uilizaion in manufacuring (compued by he Bank of Ialy based on indusrial producion and quarerly surveys by ISAE) is equal o A panel esimaion of he cos channel The fixed-effec esimaes of equaion (6) and (7) are shown respecively in Tables 6 and 7, where our hree measures of ineres rae changes ( r CR i,, r CA i,, r P ) are used alernaively as a regressor and ime dummies are included. Time dummies conrol for all aggregae effecs, including movemens in demand, cyclical behaviour of margins and, mos noably for our purposes, radiional effecs of moneary policy. 23 As a consequence, he esimaes of a 4 -a 5 in equaion (6) and b 3 b 4 in equaion (7) only capure firm-specific effecs and can be inerpreed as direcly measuring he cos effec of ineres rae changes. If firms incur coss in financing working capial, he coefficien on he firs ineracion erm (alernaively h i r CR i,, h i r CA i, h i r P ) should be posiive and equal o one. If, in addiion, firms have o anicipae labour coss, he coefficien on he second ineracion erm (alernaively (1-γ i ) r CR i,, (1-γ i ) r CA i,, (1-γ i ) r P ) should be posiive and equal o he (assumed common) proporion of labour coss ha are anicipaed. The resuls in Table 6 show ha ineres rae changes, when ineraced wih he working capial raio, affec he firm s price wih a posiive and highly significan coefficien, alhough is magniude varies across he esimaed regressions. In conras, he coefficien on he second ineracion erm is usually no significanly differen from zero (wih one excepion), indicaing ha he enire cos channel effec is explained by he amoun of working capial held by he firm, while he assumpion ha all firms have o finance he advance paymen of labour coss in he same proporion is no unambiguously suppored by he daa. When he changes in he bank rae on shor-erm bank lending applied o each firm, measured a he beginning of he period, are used o consruc he regressor (h i r CR i,-1, firs and second columns), he corresponding coefficien is posiive and saisically significan, 23 The model was esimaed alernaively wih ime dummies ineraced wih secor dummies, wih no major difference in he resuls.

19 22 alhough smaller han he uni value implied by equaion (4). I is also posiive and highly significan when he implici average ineres rae on a firms deb is used (h i r CA i,, hird and fourh second columns), alhough even smaller in absolue value. The coefficien is larger han in he previous cases and no significanly differen from 1, when he lagged change in he policy rae (h i r P -1, fifh and sixh columns) is used o consruc he regressors 24. In conras, he esimaes corresponding o coefficien a 4 are no saisically significan in wo cases ou of hree (namely, when firm-specific measures of ineres raes, (1-γ i ) r CR i, and (1-γ i ) r CA i,, are used); he esimae is posiive and significan only when aggregae ineres raes ((1-γ i )r P -1) are used. This evidence suggess ha eiher firms do no incur coss in anicipaing wages or ha he share of labour coss ha have o be anicipaed is no common across firms, as implied in deriving our equaions. When his variable is omied from he regression, he oher esimaes are no affeced (his is done in columns 2, 4 and 6 of Table 6). The esimaes of he remaining coefficiens are o a large exen consisen wih wha was expeced on he basis of equaion (4). Price changes respond one-o-one (or more) o a change in inpu prices (he coefficien on γ i v s, is always very close o 1), almos one-o-one o a change in wages (he coefficien on (1-γ i ) w s, is posiive and highly significan, bu somewha smaller han one) 25 and posiively o capaciy uilizaion (he coefficien on CU i, indicaes ha an increase in capaciy uilizaion by 10 per cen reduces he price of he firm s oupu by abou 60 basis poins). Only he link o produciviy is negaive and highly significan, bu quie small in absolue value. 26 Table 7 shows he resuls from a corresponding baery of regressions based on equaion (7), which uses firm-specific daa on uni coss raher han secoral wages and inpu prices. The esimaes of he coefficien b 3 are remarkably robus across regressions and of 24 Lagged levels of he policy rae are included, on he grounds ha i is likely o affec he average rae on firms deb wih a lag. In his case, of course, cross-secional variabiliy in h i r p -1 only depends on h i 25 Boh findings resemble hose obained by Bils and Chang (2000) on US hree-digi secoral daa. 26 The coefficien is smaller in absolue value han he one esimaed by Marchei and Nucci (2002) for various produciviy measures (heir esimaed coefficiens are somewhere around -0.3). Bils and Chang (2000) also find ha he impac of changes in TFP on he change in prices (our coefficien a 4 ) is less han one. For our purposes, he omission of his variable does no affec he esimaes of he oher coefficiens.

20 23 he same order of magniude as hose in Table 6. The coefficiens on he firm-level ineres raes, when ineraced wih working capial, are sill saisically differen from zero and smaller han one (he poin esimae is beween 0.4 and 0.6), while he coefficiens on he policy rae are also highly significan bu no saisically differen from 1. As before, he esimaes of he coefficien b 4 are inconclusive (negaive in one case, posiive in a second case, no significanly differen from zero in a hird case). Capaciy uilizaion sill eners he price equaion wih he expeced posiive sign. The coefficiens on he cos variables, uni labour cos ((1-γ i ) ULC i, ) and uni maerial cos (γ i UMC i, ) are sill posiive and significan, alhough now much smaller han 1. The esimaes of hese coefficiens may be downward biased due o measuremen errors in he dependen variables ULC, UMC, when obained from balance-shee daa. For our purposes, i is relevan ha he esimaes of he cos channel effec are robus o he change in he specificaion. All in all, our esimaes of he cos channel effec are consisen wih he model presened in Secion 3, alhough he magniude of he esimaes is somewha smaller han expeced. A possible explanaion is he relaively resricive hypohesis adoped o go from equaion (3) o equaions (4) and (5), namely ha firms insananeously adjus prices o movemens in marginal coss. In conras wih his assumpion, a large heoreical and empirical lieraure argues ha sicky price adjusmen is an essenial feaure of marke economies and ha inervals beween price revisions may someimes be fairly large. In his environmen firms do no se prices simply looking a curren marginal cos, bu a he discouned sream of expeced fuure marginal cos 27. In his case, he impac on prices of curren marginal coss would be smaller han one, ceeris paribus; he same would hold for mos explanaory variables on he righ-hand side of equaions (6) and (7), unless hey also affec fuure expeced marginal coss. Finding ou wheher his is he case is imporan, firsly, o assess wheher smaller han expeced esimaes of he cos channel effec, as in Table 6, signal a failure of he model presened in Secion 3, or can raher be explained jus by relaxing he assumpion of insananeous price adjusmen. To his end we exploi firm-level informaion on he frequency of price adjusmen available in SIM. This informaion sems from a specific

21 24 quesion ha was inroduced in he 1996 survey. In ha year he respondens were asked o choose from five possible responses o he quesion how frequenly does your firm ypically modify selling prices?. 28 The survey resuls poin o more frequen price adjusmens han found in oher inernaional sudies; in our sample, abou 70 per cen of respondens declare hey revise prices a leas every six monhs, and a hird of hem a leas every hree monhs. 29 To verify wheher he esimaed size of some parameers is closer o ha suggesed by he heoreical model when he esimaion is resriced o firms which adjus heir prices ofen, we spli he sample ino wo groups of firms. We inerac all coefficiens wih a dummy variable D, aking value 0 for he firms ha change prices a a frequency equal o or greaer han hree monhs, 1 oherwise. The resuls are repored in Table 8. As expeced, he adjusmen of prices o mos righ-hand side variables is subsanially smaller for he firms ha adjus prices infrequenly (he coefficiens on variables ineraced wih D are mosly negaive). This is no surprising and is even o a large exen obvious. Wha is more ineresing for our purposes is ha he esimaed coefficiens for he frequenly adjusing firms (hose for which D=0) now mach he heoreical model much more closely. In paricular, unlike he esimaes in he previous secion, he poin esimae of he coefficien on he change of firm-level ineres raes ineraced wih working capial is now quie close o one; he assumpion ha i is equal o one can be rejeced only in one case. This evidence reinforces he conclusion ha an effec on marginal coss is a work, whose size is enirely consisen wih he implicaions of equaion (4). 6. Is he cos channel effec economically relevan? Is he cos channel effec which we esimaed economically - in addiion o saisically - relevan? We can summarize our quaniaive resuls as follows. 27 This is he case under he assumpion of price adjusmen à la Calvo. 28 The admissible answers were: several imes a monh; every monh; every 3 monhs; every 6 monhs;, once a year or less frequenly. 29 Informaion on he frequency of acual price changes would be preferable as a measure of price sickiness. However, Blinder e al. (1996) and Hall e al. (2000) documen a srong posiive correlaion beween he frequency of price revisions and he frequency of price changes. In he case of he SIM survey, he Bank of Ialy inerviewers repored ha he re-examinaion of prices ofen coincided wih heir acual change;

22 25 Firsly, our esimaes sugges ha over he whole sample he coefficien on he ineracion variables h i r CA i,, h i r CR i, h i r P in he price equaion is beween 0.3 and 1. Secondly, in our sample, h i, he mean raio of working capial o annual operaing coss is around On average, hen, firms hold four monhs worh of operaing coss as working capial, which has o be financed. As a consequence, a one per cen rise in (annualized) ineres raes may induce an increase in prices beween 10 and 30 basis poins. Such an effec on prices, while no exraordinarily large, is no negligible. As a benchmark, in Ialy during he hree main moneary resricions in he period , he overall average policy rae increase was beween 3 and 5.5 percenage poins. These figures would imply an overall adverse effec on prices ranging from 0.3 o 1.6 percenage poins, which would have parly counerbalanced he disinflaionary effec operaing hrough he demand side. While hardly enough o change he overall effec of moneary policy on prices over he medium run, his impac may no be wihou relevance. Is his effec enough o aler he opimal course ha moneary policy should follow in response o various disurbances? A full answer goes beyond he scope of his paper, since i needs o be addressed in a general equilibrium framework. However, a enaive assessmen can be offered by considering he implicaions of he model of Ravenna and Walsh (2003). Tha model incorporaes he assumpion ha producion coss have o be anicipaed by one quarer, or, equivalenly, ha working capial is equal o one fourh of annual coss and ha is financing is enirely ransferred ono marginal coss. Tha assumpion bears a close resemblance o he feaures of our sample: he average period over which coss have o be anicipaed as working capial is slighly above one quarer, while he regressions in Table 8 show ha he corresponding ineres cos is fully refleced in marginal coss. In he Ravenna and Walsh model, under his assumpion, and for a sandard calibraion of he remaining parameers, he appropriae policy response o shocks urns ou o be affeced; he cos channel calls for a more gradual response o shocks han would oherwise happen (an illusraion is in Appendix I). furhermore, Fabiani e al. (2003) conduc a survey on a differen sample of Ialian firms and confirm he close relaionship beween he frequency of price reviews and ha of acual price changes.

23 26 7. Conclusions We draw hree implicaions from our sudy. Mehodologically, using a unique daase, we conclude ha individual daa on firms pricing behaviour give robus and direc evidence of he fac ha moneary policy also works hrough he supply side; unlike previous resuls, we consider his evidence o be largely immune o he idenificaion problem which plagues he ime-series lieraure. By observing individual firms pricing behaviour we are also able o obain a more reliable esimae of he magniude of he cos channel effec. Economically, we find he effec of ineres raes on prices o be proporional o he raio beween working capial and sales, hus supporing he view ha he cos channel effec is inrinsically linked o he role of working capial in he producion process of he firm, ha is, in he end, o a mismach beween paymens and receips. This resul is quie robus o alernaive measures of firm-level ineres raes from differen sources. In conras, we find lile evidence of a separae ineres rae effec relaed o he anicipaion of wage paymens, which is he assumpion commonly adoped in he heoreical lieraure, in addiion o ha already capured by he measure of working capial. From a normaive poin of view, he effec is economically significan; he adverse impac of ineres rae hikes on he price level during a ypical resricion cycle may no be negligible; he magniude of he supply-side effec is such ha i affecs he opimal course of policy, possibly calling for more gradualism.

24 Tables and figures Figure 1 - Oupu prices (annual percenage change) Sample mean Naional figure Sample mean: sample mean of he change in he price of oupu (source: SIM). Naional figure: annual percenage change in oupu prices, excluding food and energy (Source: Isa).

25 Figure 2 - Ineres raes (percenage poins) Definiion of he variables and sources: see ex. rp rcr (sample median) rca (sample median)

26 Figure 3 - Frequency disribuion of he ne working capial/operaing coss raio Frequency of observaions Ne working capial/operaing coss Source: CADS

27 Table 1: Number of observaions per year Year Observaions Year Observaions ,024 1,049 Table 2 - Toal sample composiion according o geographical posiion Norh-wes Norh-eas Cenre Souh and Isl. Toal Observaions Frequency Populaion in 1995 (1) Numbers in Roman ype denoe he number of firms belonging o each of he four macro regions, hose in ialics he relaive frequency of he differen groups. The source for he disribuion of he populaion of firms is Isa. (1) In 1995 he number of firms in manufacuring wih more han 50 employees was equal o In 1996 he oal number of manufacuring firms was 551,000, hose wih more han 50 employees numbered 11,453, he annual average number of firms in our sample is equal o 697.

28 Table 3 - Toal sample composiion according o size Year Toal Observaions Frequency Populaion in 1995 (1) Numbers in Roman ype denoe he number of firms belonging o each of he five size groups; hose in ialics he relaive frequency of he differen classes. The source for he disribuion of he populaion of firms is Isa. Table 4 - Toal sample composiion according o secor Year Texile, Chemicals, clohing, Meals and Manufacuring: rubber leaher and machinery ohers and plasic foowear Toal Observaions Frequency Populaion in 1995 (1)) (1) In 1995 he number of firms in manufacuring wih more han 50 employees was equal o 10,881, he annual average number of firms in our sample is equal o 697. The four secors repored in Table 4 have been obained by aggregaing wo-digi ATECO91 subsecors. Texile, clohing, leaher and foowear corresponds o subsecors DB and DC, Chemicals, rubber and plasic o subsecors DF, DG and DH, Meals and machinery o subsecors DJ, DK, DL and DM, Manufacuring: ohers o all he remaining manufacuring secors. Numbers in Roman ype normal case denoe he number of firms belonging o each of he four macro secors; hose in ialic he relaive frequency of he differen groups. The source for he disribuion of he populaion of firms is Isa. In 1995 he number of firms in manufacuring wih more han 50 employees was equal o 10881, he annual average number of firms in our sample is equal o 697.