Incomplete Cost Pass-Through Under Deep Habits

20 Pages Posted: 15 Mar 2007

See all articles by Morten O. Ravn

Morten O. Ravn

European University Institute - Economics Department (ECO); London Business School - Department of Economics; University of Southampton; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

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.

Suggested Citation

Ravn, Morten O. and Schmitt-Grohe, Stephanie and Uribe, Martin, Incomplete Cost Pass-Through Under Deep Habits (March 2007). NBER Working Paper No. w12961, Available at SSRN: https://ssrn.com/abstract=971597

Morten O. Ravn (Contact Author)

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Stephanie Schmitt-Grohe

Centre for Economic Policy Research (CEPR) ( email )

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Martin Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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