Large Shocks Travel Fast
We leverage the inflation upswing of 2022 and various granular datasets to identify robust price-setting patterns following a large supply shock. We show that the frequency of price changes increases dramatically after a large shock. We set up a parsimonious New Keynesian model and calibrate it to fit the steady-state data before the shock. The model features a significant component of state-dependent decisions, implying that large cost shocks incite firms to react more swiftly than usual, resulting in a rapid pass-through to prices -- large shocks travel fast. Understanding this feature is crucial for interpreting recent inflation dynamics.
We thank, without implicating, several colleagues and coauthors who generously provided feedback on a preliminary draft of the paper. In particular we wish to thank Fernando Alvarez, Isaac Baley, Andres Blanco, Xavier Gabaix, Erwan Gautier, Hugo Hopenhayn, Anil Kashyap, Herve Le Bihan, Claudio Michelacci, Virgiliu Midrigan, Anton Nakov, Luigi Paciello, and Facundo Piguillem. Tomas Pacheco provided excellent research assistance. Lippi acknowledges financial support from the ERC grant 101054421-DCS. Cavallo received financial support from Harvard Business School. Cavallo has an ownership stake in PriceStats LLC, a private company that provided proprietary data used in this paper without any conditions to review the findings before publication. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.