Business Cycles with Pricing Cascades

• Authors: Mishel Ghassibe and Anton Nakov.
• BSE Working Paper: 1525 | October 25
• Keywords: networks , menu costs , non-linear business cycles , large shocks

Business cycles with pronounced inflation can have sectoral origins and often feature a growing share of price-adjusting firms. Rationalizing such phenomena re- quires enhancing our modeling toolkit. We do that by building a non-linear equilibrium multi-sector framework featuring a general input-output network and optimal decisions on the timing and size of price adjustments. The interaction of our ingredients creates equilibrium cascades: large movements in aggregates trigger price adjustment decisions on the extensive margin. Following demand shocks, such as monetary interventions, networks dampen cascades, thus slowing down price adjustment decisions and giving central banks substantial power to stimulate the real economy with limited inflationary consequences. In contrast, under supply shocks, networks amplify cascades, leading to fast increases in the frequency of repricing and large inflationary swings. Applied to Euro Area data, the interaction of networks with cascades allows to quantitatively match the surges in inflation and repricing frequency in the post-Covid era.