On the Importance of Sectoral and Regional Shocks for Price Setting
We use a novel disaggregate sectoral euro area data set with a regional breakdown to investigate price changes and suggest a new method to extract factors from over-lappingdata blocks. This allows us to separately estimate aggregate, sectoral, country-specific and regional components of price changes. We thereby provide an improved estimateof the sectoral factor in comparison with previous literature, which decomposes pricechanges into an aggregate and idiosyncratic component only, and interprets the latter assectoral. We find that the sectoral component explains much less of the variation in sectoral regional inflation rates and exhibits much less volatility than previous findings forthe US indicate. We further contribute to the literature on price setting by providing evidence that country- and region-specific factors play an important role in addition to thesector-specific factors, emphasising heterogeneity of inflation dynamics along different dimensions. We also conclude that sectoral price changes have a “geographical” dimension, that leads to new insights regarding the properties of sectoral price changes.