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The Passthrough of Large-cost Shocks in an Inflationary Economy

In: Changing Inflation Dynamics,Evolving Monetary Policy

Author

Listed:
  • Fernando Álvarez

    (University of Chicago and NBER)

  • Pablo Andrés Neumeyer

    (Universidad Torcuato Di Tella)

Abstract

We describe several events in Argentina between 2012 and 2018 in which public utilities or the exchange rate increase by a large amount in a single month. During these months the nominal increase in our measure of the cost of the goods included in the core CPI was as high as 10%. Motivated by these events, we use a menu cost model of price adjustment to derive the theoretical pass-through of large cost shocks to consumer prices for an economy with an underlying inflation rate of the order of 25% per year, as well as the impact of these shocks on the size and on the frequency of price changes. Using a comprehensive, never used in the price adjustment literature, micro-data set underlying the construction of the core CPI for the city of Buenos Aires we compare the theoretical effect of the cost shocks to the empirical one. As predicted by the theory we find that despite the high level of underlying inflation, the large frequency of both price increases and decreases points to the importance of idiosyncratic firm shocks, such as the ones we use in our model. Right after large increases in costs, both the fraction of price increases and the average size of price increases dramatically rises, while the size of price decreases stays approximately the same, just at the simple model predicts. On the other hand, the model predicts a small decrease in the fraction of price decreases which we don't observe in the data. We conclude that for large sudden changes in cost, consumer prices behave almost as if they were fully flexible. On the other hand, for small shocks the short-term pass-through will be smaller and its half-life larger.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Fernando Álvarez & Pablo Andrés Neumeyer, 2020. "The Passthrough of Large-cost Shocks in an Inflationary Economy," Central Banking, Analysis, and Economic Policies Book Series, in: Gonzalo Castex & Jordi Galí & Diego Saravia (ed.),Changing Inflation Dynamics,Evolving Monetary Policy, edition 1, volume 27, chapter 2, pages 007-048, Central Bank of Chile.
  • Handle: RePEc:chb:bcchsb:v27c02pp007-048
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    References listed on IDEAS

    as
    1. Etienne Gagnon & David López-Salido & Nicolas Vincent, 2013. "Individual Price Adjustment along the Extensive Margin," NBER Macroeconomics Annual, University of Chicago Press, vol. 27(1), pages 235-281.
    2. Barthélémy Bonadio & Andreas M Fischer & Philip Sauré, 2020. "The Speed of Exchange Rate Pass-Through," Journal of the European Economic Association, European Economic Association, vol. 18(1), pages 506-538.
    3. Fernando Alvarez & Francesco Lippi, 2014. "Price Setting With Menu Cost for Multiproduct Firms," Econometrica, Econometric Society, vol. 82(1), pages 89-135, January.
    4. Andrew S. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(4), pages 703-725.
    5. Fernando Alvarez & Francesco Lippi & Juan Passadore, 2017. "Are State- and Time-Dependent Models Really Different?," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 379-457.
    6. Peter Karadi & Adam Reiff, 2019. "Menu Costs, Aggregate Fluctuations, and Large Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(3), pages 111-146, July.
    7. Fernando Alvarez & Martin Beraja & Martín Gonzalez-Rozada & Pablo Andrés Neumeyer, 2019. "From Hyperinflation to Stable Prices: Argentina’s Evidence on Menu Cost Models," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(1), pages 451-505.
    8. Etienne Gagnon, 2009. "Price Setting during Low and High Inflation: Evidence from Mexico," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 124(3), pages 1221-1263.
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    10. Acemoglu, Daron & Parker, Jonathan A. & Woodford, Michael (ed.), 2013. "NBER Macroeconomics Annual 2012," National Bureau of Economic Research Books, University of Chicago Press, number 9780226052779, July.
    11. Fernando Alvarez & Hervé Le Bihan & Francesco Lippi, 2016. "The Real Effects of Monetary Shocks in Sticky Price Models: A Sufficient Statistic Approach," American Economic Review, American Economic Association, vol. 106(10), pages 2817-2851, October.
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