Working Paper: NBER ID: w16065
Authors: Gita Gopinath; Oleg Itskhoki
Abstract: The closed and open economy literatures work on evaluating the role of real rigidities, but in parallel. This paper brings the two literatures together. We use international price data and exchange rate shocks to evaluate the importance of real rigidities in price setting. We show that consistent with the presence of real rigidities the response of reset-price inflation to exchange rate shocks depicts significant persistence. Individual import prices, conditional on changing, respond to exchange rate shocks prior to the last price change. At the same time aggregate reset-price inflation for imports, like that for consumer prices, depicts little persistence. Competitor prices affect firm pricing, and exchange rate pass-through into import prices is greater in response to trade-weighted as opposed to bilateral exchange rate shocks. We quantitatively evaluate sticky price models (Calvo and menu cost) with variable markups at the wholesale level and constant markups at the retail level, consistent with empirical evidence. Variable markups alone generate price sluggishness at the aggregate level, while they fall short of matching price persistence at the micro level. Finally, variable markups magnify the size of the contract multiplier, but their absolute effects are modest unless they are coupled with exogenous sources of persistence.
Keywords: real rigidities; price setting; exchange rate shocks; sticky prices; monetary non-neutrality
JEL Codes: E31; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real rigidities (D43) | reset-price inflation (E31) |
| exchange rate shocks (F31) | reset-price inflation (E31) |
| exchange rate shocks (F31) | individual import prices (F14) |
| reset-price inflation (E31) | pricing behavior (D40) |
| trade-weighted exchange rates (F31) | passthrough of exchange rate changes into import prices (F31) |
| competitor pricing (L11) | firm pricing decisions (L11) |
| variable markups (D46) | price sluggishness (P22) |
| strategic complementarities (D10) | pricing decisions (L11) |
| reset-price inflation (E31) | lagged effect in pricing behavior (D40) |