JDI Research Associate Brock Mutic interviews Queen’s Economics Department (QED) Professor Allen Head about ongoing research and Canadian public policy

Queen’s Economics Department Professor Allen Head, in an ongoing research project in collaboration with Professor Beverly Lapham and former Queen’s Ph.D. student Dr. Alex Chernoff, has been investigating how productivity is distributed, and how consumers search for products, across the Canadian retail market. The research, in uncovering how Canadian retail prices are affected by cost pass-through and demand changes, has the potential to improve our understanding of how inflation operates in the Canadian context. This summer, the QED blog caught up with Dr. Head, in anticipation of his forthcoming research, to learn more about his exciting project. 

QED Blog: It’s great to speak with you, Professor Head. Can you please tell us a bit about your current research project? 

Dr. Allen Head (A.H): As you explained, the new research, in collaboration with Professor Lapham and Dr. Chernoff, jointly estimates the productivity distributions and consumer search processes for retail industries in Canada. We do this using detailed firm-level data on Canadian retail firms, including information on their revenue, costs of goods sold, and profits. 

QED Blog: How did your background lead you to this work?  

A.H: My work in this area has mostly been in the context of monetary economies, where I have studied pass-through, price stickiness, and the welfare effects of inflation. Previously, I have worked with Professor Lapham on a number of projects, in which we have used similar models to the one we are using in this new research to understand the relationship between inflation and market power, and also the extent of pass-through of cost and monetary shocks to price changes. Professor Lapham has also worked on pass-through in similar settings, which explicitly include heterogeneous firms. In particular, she has a recent paper in the Journal of International Economics using firm-level data to estimate the effects of cross-border shopping on firms’ revenues in the presence of incomplete exchange rate pass-through. Both she and Dr. Chernoff have extensive experience working with microdata. Alex also has experience using the econometric techniques we are using in the estimation of the structural model. 

QED Blog: How does this work differ from previous research on productivity at the firm level? 

A.H: There is substantial empirical literature measuring the productivity of firms that produce differentiated products under conditions of constant elasticity demand. The theory in that literature was pioneered by Marc Melitz, Hugo Hopenhayn, and Richard Rogerson, and we see our work as complementary to their approach. In our new project, we model market power as arising from search frictions rather than from product differentiation, consider more general demand structures, and focus on retail firms rather than manufacturing establishments. A distinguishing characteristic of our approach is that market power (measured by the ‘mark-up’ of price over marginal cost) differs across firms of differing productivity, is determined endogenously in equilibrium, and responds to changes to consumers’ search behaviour, external shocks to costs, and to government policy. 

QED Blog: What are the potential policy implications of this work? 

A.H: By focusing on the extent of the pass-through of cost and demand changes to prices, the theory has the potential to improve our understanding of inflation, especially that driven by conditions of tight supply such as may have arisen as a result of the pandemic and its effects on the supply chain. Pass-through is direct and complete in the alternative literature mentioned above, whereas in our theory, it is typically incomplete and non-constant, varying with underlying economic conditions, industry characteristics, and unexpected shocks. As such, the model can address the magnitude of price changes emanating from various sources and has predictions for changes in relative prices across industries and goods. 

Given this, the model speaks directly to monetary policy. The inflation-targeting strategies employed by many Central Banks, including the Bank of Canada, rely on accurate forecasts of inflation. Thus, models of how prices respond to changing conditions can be useful in informing such policies. 

QED Blog: Where is the project going from here? 

A.H: At this point, we have developed the structural model and estimation techniques. Monte Carlo exercises have shown that our estimation techniques work well, so now we are in the process of estimating the model using firm-level data on Canadian firms from Statistics Canada. Preliminary estimation using this data is going well. Once we have final estimates, we will use the model in a series of policy experiments, focusing largely on the effects of shocks and monetary policy actions on the responses of prices and markups. 

QED Blog: Thanks for your time! We look forward to hearing more about this research in the future!