Large Shocks Travel Fast
American Economic Review: Insights 6 (4), 558–574 (2024)
Abstract
We document a sizeable increase in the frequency of price adjustments following the large energy shocks of 2022. We use a tractable New Keynesian model, calibrated to the pre-shock data, to interpret such a pattern. The calibration highlights the state dependence of firms’ decisions: prices are adjusted rapidly when markups are misaligned.
In the model, a large cost shock triggers a swift increase in the frequency of price adjustments, causing a rapid pass-through from costs to prices. Time-dependent models, such as the Calvo model, miss this frequency response, failing to capture the sudden inflation surge after a large shock.