TY  - JOUR
AU  - Ravn,Morten
AU  - Schmitt-Grohe,Stephanie
AU  - Uribe,Martin
TI  - Incomplete Cost Pass-Through Under Deep Habits
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12961
PY  - 2007
Y2  - March 2007
UR  - http://www.nber.org/papers/w12961
L1  - http://www.nber.org/papers/w12961.pdf
N1  - Author contact info:
Morten Ravn
Department of Economics
University College London
London WC1E 6BT
UK
E-Mail: morten.ravn@eui.eu

Stephanie Schmitt-Grohe
Department of Economics
Columbia University
New York, NY 10027
Tel: 212/854-8059
Fax: 212/854-4010
E-Mail: stephanie.schmittgrohe@columbia.edu

Martin Uribe
Department of Economics
Columbia University
International Affairs Building
New York, NY 10027
Tel: 212 851 4008
Fax: 212 854 8059
E-Mail: martin.uribe@columbia.edu
AB  - A number of empirical studies document that marginal cost shocks are not fully passed through to prices at the firm level and that prices are substantially less volatile than costs. We show that in the relative-deep-habits model of Ravn, Schmitt-Grohe, and Uribe (2006),  firm-specific marginal cost shocks are  not fully passed through to product prices. That is, in response to a firm-specific increase in marginal costs, prices rise, but by less than marginal costs leading to a decline in the firm-specific markup of prices over marginal costs. Pass-through is predicted to be even lower when shocks to marginal costs are anticipated by firms. In our model, unanticipated firm-specific cost shocks lead to incomplete pass-through (or a decline in markups) of about 20 percent  and  anticipated cost shocks are associated with incomplete pass-through of about 50 percent.  The model predicts that cost pass-through is increasing in the persistence of marginal cost shocks and U-shaped in the strength of habits. The relative-deep-habits  model implies that conditional on marginal cost disturbances, prices are less volatile than marginal costs.
ER  -