Micro and Macro Cost-Price Dynamics in Normal Times and During Inflation Surges

We study cost-price dynamics in normal times and during inflation surges. Using microdata on firms’ prices and production costs we construct an empirical measure of price gaps—the deviation between a firm’s listed and optimal price. We then examine the mapping between gaps and price changes in the cross-section of firms and derive implications for inflation dynamics in the time-series. In the microdata, pricing policies display state-dependence: firms are more likely to adjust prices as their price gap widens, a mechanism that becomes quantitatively significant when large aggregate cost shocks occur. In normal times, adjustment probabilities are approximately constant and the microdata conform with the predictions of time-dependent models (e.g., Calvo 1983). Conditional on a path of aggregate cost shocks extracted from the data, we show that a generalized state-dependent pricing model accounts well for the pre-pandemic era’s low and stable inflation and the nonlinear surge observed during the pandemic.