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Incomplete Cost Pass-Through Under Deep Habits

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  • Morten Overgaard Ravn

    (European University Institute)

  • Stephanie Schmitt-Grohe

    (Columbia University)

  • Martin Uribe

    (Columbia University)

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. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 13 (2010)
Issue (Month): 2 (April)
Pages: 317-332

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Handle: RePEc:red:issued:08-186

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Keywords: Deep habit formation; Markups; Cost pass-through;

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References

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Cited by:
  1. Reto Foellmi & Christian Hepenstrick & Josef Zweimüller, 2010. "Non-homothetic preferences, parallel imports and the extensive margin of international trade," Diskussionsschriften, Universitaet Bern, Departement Volkswirtschaft dp1009, Universitaet Bern, Departement Volkswirtschaft.
  2. Pinelopi Koujianou Goldberg & Rebecca Hellerstein, 2006. "A Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical Application," 2006 Meeting Papers, Society for Economic Dynamics 625, Society for Economic Dynamics.
  3. Adachi, Takanori & Ebina, Takeshi, 2014. "Double marginalization and cost pass-through: Weyl–Fabinger and Cowan meet Spengler and Bresnahan–Reiss," Economics Letters, Elsevier, Elsevier, vol. 122(2), pages 170-175.
  4. di Pace, Federico & Faccini, Renato, 2010. "Deep habits and the cyclical behaviour of equilibrium unemployment and vacancies," Bank of England working papers, Bank of England 391, Bank of England.
  5. Hellerstein, Rebecca & Villas-Boas, Sofia B., 2010. "Outsourcing and Pass-Through," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series, Department of Agricultural & Resource Economics, UC Berkeley qt8098p5nq, Department of Agricultural & Resource Economics, UC Berkeley.
  6. Isaac Kleshchelski & Nicolas Vincent, 2007. "Market Share and Price Rigidity," Cahiers de recherche 08-01, HEC Montréal, Institut d'économie appliquée.

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