Incomplete Cost Pass-Through Under Deep Habits

Morten Ravn, Stephanie Schmitt-Grohe and Martín Uribe ()

No ECO2008/06, Economics Working Papers from European University Institute

Abstract: A number of empirical studies document that marginal cost shocks are not fully passed through to prices at the firm level and that prices are substantially less volatile than costs. We show that in the relative-deep-habits model of Ravn, Schmitt-Grohe, and Uribe (2006), firm-specific marginal cost shocks are not fully passed through to product prices. That is, in response to a firm-specific increase in marginal costs, prices rise, but by less than marginal costs leading to a decline in the firm-specific markup of prices over marginal costs. Pass-through is predicted to be even lower when shocks to marginal costs are anticipated by firms. In our model unanticipated firm-specific cost shocks lead to incomplete pass-through (or a decline in markups) of about 20 percent and anticipated cost shocks are associated with incomplete pass-through of about 50 percent. The model predicts that cost pass-through is increasing in the persistence of marginal cost shocks and U-shaped in the strength of habits. The relative-deep-habits model implies that conditional on marginal cost disturbances, prices are less volatile than marginal costs.

Keywords: Deep Habit formation; Markups; Cost Pass-Through (search for similar items in EconPapers)
JEL-codes: D1 D4 L1 (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Incomplete Cost Pass-Through Under Deep Habits (2010)
Journal Article: Incomplete cost pass-through under deep habits (2008)
Working Paper: Incomplete Cost Pass-Through Under Deep Habits (2008)
Working Paper: Incomplete Cost Pass-Through Under Deep Habits (2007)
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