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 and balance sheet data, I quantify the monetary policy rate pass-through to producer prices via the working capital channel. I develop a theoretical framework based on the New Keynesian model to show that the monetary policy transmission mechanism depends on heterogeneity in firms' working capital holdings and firms' anticipation of policy rate changes. The model predicts that (i) an increase in the policy rate leads to an increase in firms prices, (ii) it results in larger increases in the prices of firms that require more working capital, and (ii) unanticipated interest rate changes have larger current effects on producer prices than anticipated interest rate changes. The predictions of the model are tested using Swedish firm-level micro data. Specifically, I compare the price response of firms with high and low working capital holdings upon changes in the repo rate, and as a reaction to three sets of monetary policy shocks. The empirical results show that the pass-through of a percent increase in the policy rate to producer prices via the working capital channel is between 0.1-0.5 percent for the firm with average working capital holdings over a three month price setting horizon. The effect is 0.2-0.7 two quarters ahead. For a firm whose working capital requirement equals its sales, a percent increase in the policy rate increases the firm's price by 1.3-5.6 percent via the working capital channel over a one year horizon. The second set of results show that interest rate changes are likely unanticipated by firms, suggesting that actual policy rate changes are sufficient 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