Volatility and Pass-through
Time-variation in microdata matters empirically for aggregate dynamics: using confidential BLS data we document a robust positive relationship between aggregate exchange rate pass-through and the dispersion of item-level price changes. Furthermore, we find large time-variation in microeconomic dispersion. Ignoring this variation causes huge, time-varying bias when estimating pass-through. For example, constant pass-through specifications are overstated by 50 percent during the mid-1990s and understated by 200 percent during the 2008 trade-collapse. This purely empirical result arises naturally if items differ in their "responsiveness" to cost shocks. More responsive items should have greater price change dispersion and pass-through. We formally estimate price-setting models with alternative forms of heterogeneity and show only heterogeneous responsiveness explains our results. Interestingly, our evidence does not support "uncertainty" shocks as an explanation for countercyclical dispersion but does suggest promising alternatives.
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