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Shocks vs. Responsiveness: What Drives Time-Varying Dispersion?

David Berger, Joseph Vavra

NBER Working Paper No. 23143
Issued in February 2017
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Industrial Organization, Monetary Economics

The dispersion of many economic variables is countercyclical. What drives this fact? Greater dispersion could arise from greater volatility of shocks or from agents responding more to shocks of constant size. Without data separately measuring exogenous shocks and endogenous responses, a theoretical debate between these explanations has emerged. In this paper, we provide novel identification using the open-economy environment: using confidential BLS microdata, we document a robust positive relationship between exchange rate pass-through and the dispersion of item-level price changes. We show this relationship arises naturally in models with time-varying responsiveness but is at odds with models featuring volatility shocks.

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Document Object Identifier (DOI): 10.3386/w23143

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