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Inflation dynamics during the financial crisis

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Firms with limited internal liquidity significantly increased prices in 2008, while their liquidity unconstrained counterparts slashed prices. Differences in the firms' price-setting behavior were concentrated in sectors likely characterized by customer markets. The authors develop a model in which firms face financial frictions while setting prices in a customer-markets setting. Financial distortions create an incentive for firms to raise prices in response to adverse demand or financial shocks. These results reflect the firms' reaction to preserve internal liquidity and avoid accessing external finance, factors that strengthen the countercyclical behavior of markups and attenuate the response of inflation to fluctuations in output.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta CQER Working Paper with number 2015-4.

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Length: 51 pages
Date of creation: 01 Nov 2015
Handle: RePEc:fip:fedacq:15-04
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