Seminar

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

Oleg Itskhoki (Princeton University)

June 1, 2015, 17:00–18:30

Room MF 323

Macroeconomics Seminar

Abstract

How strong are strategic complementarities in price setting across firms? Are these strategic complementarities important in shaping the response of domestic prices to international shocks? 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 that does not rely on a particular model of variable markups, which allows us to estimate the elasticities of a firm’s price response to both its own cost shocks and to the price changes of its competitors. Our approach takes advantage of the new micro-level dataset that we construct for the Belgian manufacturing sector, which contains the necessary information on firms’ domestic prices, their marginal costs, and competitors’ prices. The rare features of these data enable us to develop an identification strategy that takes into account the simultaneity of price setting by competing firms. We find strong evidence of strategic complemen-tarities: a typical firm changes its price with an elasticity of 35% in response to the price changes of its competitors and with an elasticity of 65% in response to its own cost shocks. We further show there is a lot of heterogeneity in these elasticities across firms, with small firms exhibiting no strategic complementarities and complete cost pass-through, while large firms responding to their cost shocks and competitor price changes with roughly equal elasticities of around 50%. To explore the implications of these findings for the transmission of international shocks into domestic prices, we calibrate a model of variables markups to match the salient features we identify in the data. We use the calibrated model to study counterfactual scenarios for the response of costs, markups and prices to an exchange rate devaluation across firms and industries.