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Glenn Magerman, ECARES Print
Tuesday, 05 February 2019, 14:00 - 15:15

Glenn Magerman, ECARES

Price Updating with Production Networks

Abstract:  Firms do not completely pass through their cost shocks onto output prices, generating variable markups that allow for dampening of price movements across firms. While the impact of partial cost shocks such as exchange rate volatility are well-documented, much less is known about general cost pass through at the micro level, and its implications for aggregate outcomes such as propagation through value chains and aggregation to inflation. This paper evaluates how firms change their prices in response to cost shocks and other price changes in their environment. We first docu- ment three new facts on the heterogeneity of firm-level producer prices and their relationship to buyers and suppliers in a production network. We then develop a non-parametric framework of how producers update their prices, taking into account this production network. The framework is very general, and accounts for the heterogeneity in price changes and the production network from the stylized facts. Moreover, the framework is consistent with various price setting mechanisms, and does not impose a particular market structure or demand functional form. Exploiting rich data on producer prices and the network structure of production in Belgium, we estimate the model to evaluate the importance of both channels in the data. We find that, on average, input price pass-through is incomplete and very much below one, while firms also strongly react to other prices in their environment. Next, we study the propagation and aggregation properties of incomplete pass-through. A shock of 10% to import prices at the firm level generates a change in producer prices that is roughly one third of that compared to models with complete pass-through. Includ- ing production networks with incomplete passthrough solves the puzzle of inflation forecasting models that assume perfect pass-through but are unable to match the volatility of import prices to that of consumer prices.

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