Volatility and Pass-through
The response of inflation to nominal shocks varies across time: we use confidential BLS micro data to show that there is a robust positive relationship between exchange rate pass-through and the dispersion of item-level price changes. Furthermore, we show that time-variation in price change dispersion is both large and countercyclical so that ignoring microeconomic dispersion leads to large time-varying bias when estimating pass-through. Why does pass-through vary with microeconomic dispersion? We estimate a quantitative price-setting model with various sources of heterogeneity in order to interpret our “model-free” empirical results and to better understand the economic forces that shape the response of prices to cost shocks at a moment in time. We conclude that strategic complementarities, which have received wide attention for their role in shaping average pass-through, also appear to vary dramatically across time. In contrast, we find no evidence supporting the "uncertainty" shock literature, which posits time-variation in underlying cost shocks as an explanation for time-variation in dispersion.
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This paper was revised on July 14, 2014
Document Object Identifier (DOI): 10.3386/w19651
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