The Pass-Through of Large Cost Shocks in an Inflationary Economy

Pablo Neumeyer

No 1582, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We describe several events in Argentina between 2012 and 2018 in which public utilities or the exchange rate increased 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 as 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.

Date: 2019
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Related works:
Chapter: The Passthrough of Large-cost Shocks in an Inflationary Economy (2020)
Working Paper: The Pass-Through of Large Cost Shocks in an Inflationary Economy (2019)
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