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Inflation Dynamics During the Financial Crisis

Simon Gilchrist (), Raphael Schoenle, Jae Sim and Egon Zakrajsek ()

No 78, Working Papers from Brandeis University, Department of Economics and International Businesss School

Abstract: Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), this paper analyzes the effect of changes in firms’ financial conditions on their price-setting behavior during the “Great Recession.” The evidence indicates that during the height of the crisis in late 2008, firms with “weak” balance sheets increased prices significantly, whereas firms with “strong” balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeco- nomic shocks. We explore the implications of these empirical findings within the New Keynesian general equilibrium framework that allows for customer markets and departures from the fric- tionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment oppor- tunities and maintain high prices in an effort to preserve their balance-sheet capacity. Consistent with our empirical findings, the model with financial distortions—relative to the baseline model without such distortions—implies a substantial attenuation of price dynamics in response to contractionary demand shocks.Length: 59 pages

Keywords: Producer Price Inflation; Customer Markets; Financial Frictions (search for similar items in EconPapers)
JEL-codes: E31 E32 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2013-09
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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP78.pdf First version, 2014 (application/pdf)

Related works:
Journal Article: Inflation Dynamics during the Financial Crisis (2017) Downloads
Working Paper: Inflation Dynamics During the Financial Crisis (2016) Downloads
Working Paper: Inflation dynamics during the financial crisis (2015) Downloads
Working Paper: Inflation Dynamics During the Financial Crisis (2015) Downloads
Working Paper: Inflation Dynamics During the Financial Crisis (2014) Downloads
Working Paper: Inflation Dynamics During the Financial Crisis (2013) Downloads
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