Energy Price Uncertainty and Decreasing Pass-through to Core Inflation

This paper uses an extended version of the New Keynesian model to provide an alternate explanation for the decrease in energy price pass-through to core inflation. Results show that in a model with households' consumption of energy goods, uncertain energy prices decrease firms' responsiveness to an energy price shock. This is due to the upward pricing bias channel in firms' pricing decision. Since prices are sticky firms bias their prices upwards. The pricing bias provides cushion to firms against future cost shocks. Increase in energy price uncertainty further increases the magnitude of the bias. As a result, when a positive energy price shock hits the economy, firms require a smaller increase in their prices than they would have in absence of the pricing bias.