On the importance of sectoral and regional shocks for price-setting

We use novel disaggregate sectoral-regional euro-area data to investigate the sources of price changes, introducing a new method to extract factors from overlapping data blocks that allows for estimation of aggregate, sectoral, country-specific and regional components of price changes. Our sectoral component explains much less variation in disaggregate inflation rates and exhibits much less volatility and more persistence than previous findings for the US indicate. Country- and region-specific factors play an important role, emphasizing heterogeneity of inflation dynamics along both sectoral and geographical dimensions. Our results are incompatible with basic sticky-information or Calvo-type price-setting models, but require multi-sector, multi-country models.