Using Brexit To Identify the Nature of Price Rigidities
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Using price quote data that underpin the official U.K. consumer price index (CPI), we analyze the effects of the unexpected passing of the Brexit referendum on the dynamics of price adjustments. The sizable depreciation of the British pound that immediately followed Brexit works as a quasi-experiment, enabling us to study the transmission of a large common marginal cost shock to inflation as well as the distribution of prices within granular product categories. The bulk of the aggregate inflationary effect is attributable to the size of price adjustments, an aspect matched well by the time-dependent price-setting model. The state-dependent model fares better in capturing the endogenous selection of price changes at the lower end of the price distribution. Both models miss on the magnitude of the adjustment conditional on selection.