Job Market Paper
Price changes affect the distribution of economic resources and the drivers of inflation are central to monetary policy decisions. My paper examines how changes in market structure and product market concentration, specifically firm exit, affect prices. I develop a model in which firms are heterogeneous in their costs and market power. In the model, firms exit when they cannot pay their costs. The model predicts that the remaining firms' markups and prices increase after their competitors exit. I test my model's prediction with Swedish firm-level micro data. I use the exposure of firms to a bank, which was severely affected by the financial crisis, as an instrument to identify the causal relationship between firm exit and prices. I find that the remaining firms increase their prices by 0.3 percent when a set of firms with a combined market share of one percent exit. The estimated rise in prices from an increase in exit puts an upward pressure on inflation during recessions. Thus, my findings help understand the lack of price fall during the financial crisis - referred to as the “missing disinflation” puzzle. My empirical findings, in which the effect of exit on prices is larger than in the model, suggest that the role of entry and exit may be larger than current theoretical models with variable markups predict. I show that the model can be brought into line with the data under the assumption that industries are divided into sub-markets.
Using a novel dataset, which merges firm-level producer price (PPI) and balance sheet data, this study shows that the working capital channel is important for firm’ price setting behavior. The working capital channel introduces interest payments in the firm’s marginal cost, which make producer prices increasing in the policy rate. This is the first empirical paper to show firm-level evidence of the working capital channel as it is used in workhorse New Keynesian models. The role of the working capital channel in standard New Keynesian models is to create a direct supply-side monetary policy transmission mechanism that can generate price responses consistent with the price puzzle observed in aggregate data. The empirical results show that the pass-through of a one percentage point interest rate change to the producer price via the working capital channel is 0.9 percentage point for the firm with average working capital holdings over a five month price setting horizon. The paper extends the traditional model of the working capital channel by differentiating between anticipated and unanticipated interest rate changes in order to examine how important unanticipated interest rate changes are for the firm’s price setting behavior. The theoretical framework predicts that unanticipated interest rate changes have a larger impact on prices than anticipated interest rate changes. The empirical results show that interest rate changes are fully unanticipated by the firm so it is sufficient to use actual interest rate changes to measure the supply-side policy rate pass-through.
Markups as a Hedge for Input Price Uncertainty
with Sneha Agrawal and Abhishek Gaurav
In this paper, we propose a new channel to explain higher markups and incomplete pass-through of input prices to markups. Standard models in the literature often do not consider second-moment changes in input prices, that is, the uncertainty in costs the producers face while deciding prices. This uncertainty, along with the fact that prices are sticky in the sense that firms often choose prices knowing only their cost distribution and not the actual cost realization, might lead to much lower dividends than expected. As a result, firms have a precautionary motive to charge higher markups ex-ante and insure against high future cost uncertainty. We corroborate this with evidence on oil-price and real-exchange-rate volatility shocks in a large panel data of firms from Sweden. We find that higher cost uncertainty for firms with intensive use of oil or imports (respectively) leads to an increase in markups by 3%-7% annualized.
Work in Progress
The Effect of International Competition on R&D and Product Quality
with Michael Gilraine, Scott Orr and Daniel Trefler
Globally Dominant Firms
with Thomas Philippon and Germán Gutiérrez
Changes in the Number of Firms and the Market Share Distribution
with Joshua Weiss
Optimal Price Index in an Open Economy
with David Vestin