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Federal Reserve Bank of San Francisco
Working Paper Series
Sticker shocks: using VAT changes to estimate upper-level elasticities of substitution
Bart Hobijn
Fernanda Nechio
Abstract

We estimate the upper-level elasticity of substitution between goods and services of a nested aggregate CES preference specification. We show how this elasticity can be derived from the long-run response of the relative price of a good to a change in its VAT rate. We estimate this elasticity using new data on changes in VAT rates across 74 goods and services for 25 E.U. countries from 1996 through 2015. Our results point to an upper-level elasticity of between 1, at a high level of aggregation that distinguishes 12 categories of goods and services, and 3, at the lowest level of aggregation with 74 categories.


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Bart Hobijn & Fernanda Nechio, Sticker shocks: using VAT changes to estimate upper-level elasticities of substitution, Federal Reserve Bank of San Francisco, Working Paper Series 2015-17, 26 Oct 2015, revised Oct 2017.
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DOI: 10.24148/wp2015-17
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