Inflation Dynamics in Production Networks

This study empirically examines the differences in inflation dynamics between the US and Japan. Using a structural model of sectoral inflation, we quantify the roles of production networks, price stickiness, and structural shocks in driving these variations. Our partial equilibrium framework captures sectoral inflation as a tractable form, enabling us to estimate the model and analytically explore the channels through which pass-through to inflation operates. The model can generate inflation persistence across sectors through production networks, further reinforced by price stickiness within each sector. The full-information Bayesian estimation results reveal that impulse response functions to sectoral shocks are similar between the two countries but that differences in inflation dynamics arise from two factors: the different sources of specific sectoral inflation, particularly in an energy-related sector, and contrasting price-setting behaviors. US firms tend to change prices in the same direction as import price shocks, leading to higher pass-through, whereas Japanese firms are inclined to set prices to absorb import price shocks. Policy experiments based on the estimated model demonstrate that a 10% increase in tariffs results in a 0.6–1.2% rise in US producer price inflation.