International Shocks and Domestic Prices: How Large are Strategic Complementarities?

56 Pages Posted: 31 May 2016 Last revised: 30 Aug 2017

See all articles by Mary Amiti

Mary Amiti

Federal Reserve Bank of New York

Oleg Itskhoki

Princeton University - Department of Economics

Jozef Konings

Catholic University of Leuven (KUL) - LICOS - Centrum voor Transitie-economie; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Multiple version iconThere are 3 versions of this paper

Date Written: 2016-03-01

Abstract

How strong are strategic complementarities in price setting across firms? In this paper, we provide a direct empirical estimate of firms’ price responses to changes in prices of their competitors. We develop a general framework and an empirical identification strategy to estimate the elasticities of a firm’s price response both to its own cost shocks and to the price changes of its competitors. Our approach takes advantage of a new micro-level data set for the Belgian manufacturing sector, which contains detailed information on firm domestic prices, marginal costs, and competitor prices. The rare features of these data enable us to construct instrumental variables to address the simultaneity of price setting by competing firms. We find strong evidence of strategic complementarities, with a typical firm adjusting its price with an elasticity of 35 percent in response to the price changes of its competitors and with an elasticity of 65 percent in response to its own cost shocks. Furthermore, we find substantial heterogeneity in these elasticities across firms, with small firms showing no strategic complementarities and a complete cost pass-through, and large firms responding to their cost shocks and competitor price changes with roughly equal elasticities of around 50 percent. We show, using a tightly calibrated quantitative model, that these findings have important implications for shaping the response of domestic prices to international shocks.

Keywords: strategic complementarities, pass-through, exchange rates, prices, mark-up

JEL Classification: D22, E31, F31

Suggested Citation

Amiti, Mary and Itskhoki, Oleg and Konings, Jozef, International Shocks and Domestic Prices: How Large are Strategic Complementarities? (2016-03-01). FRB of NY Staff Report No. 771. Available at SSRN: https://ssrn.com/abstract=2786190

Mary Amiti (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Oleg Itskhoki

Princeton University - Department of Economics ( email )

Fisher 306
Princeton, NJ 08544-1021
United States
+1 (609) 258-5493 (Phone)

HOME PAGE: http://www.princeton.edu/~itskhoki

Jozef Konings

Catholic University of Leuven (KUL) - LICOS - Centrum voor Transitie-economie ( email )

Waaistraat 6 - box 3511
Leuven, 3000
Belgium
+32 16 326 589 (Phone)
+32 16 326 599 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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