Inflation Dynamics During the Financial Crisis

By Simon Gilchrist, Raphael S. Schoenle, J. Sim, Egon Zakraǰsek. 2015

435 citations recorded by the source corpus.

Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), this paper analyzes the effect of changes in firms’ financial conditions on their price-setting behavior during the ”Great Recession” that surrounds the financial crisis. The evidence indicates that during the height of the crisis in late 2008, firms with “weak” balance sheets increased prices significantly relative to industry averages, whereas firms with “strong” balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeconomic shocks. We explore the implications of these empirical findings within a general equilibrium framework that allows for customer markets and departures from the frictionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment opportunities and maintain high prices in an effort to preserve their balance-sheet capacity. Consistent with our empirical findings, the model with financial distortions—relative to the baseline model without such distortions—implies a substantial attenuation of price dynamics in response to contractionary demand shocks.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/3d0f08d2228bd163359a53bb691407ceb47c88ce

How researchers see this paper

The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.

In Economics and Econometrics

Citations in the corpus

House Prices, Local Demand, and Retail Prices (2019, neutral): “Conversely, during the housing bust and the Great Recession, increasing financial frictions likely pushed prices to increase (see Ball and Mazumder, 2011; Del Negro, Giannoni and Schorfheide, 2014; Gilchrist et al., 2014).”
Optimal Inflation and the Identification of the Phillips Curve (2019, methodology): “As an example, the explanations in the DSGE models of Christiano, Eichenbaum and Trabandt (2015) and Gilchrist et al. (2017) for the lack of disinflation during the financial crisis rely on financial frictions that simultaneously increased inflation and decreased real activity. That suggests one may”
The Effects of COVID-19 on U.S. Small Businesses: Evidence from Owners, Managers, and Employees (2020, background): “In contrast, Gilchrist et al. (2017) conclude that financial constraints lead to an increase in product prices.”
A Phillips Curve with Anchored Expectations and Short-Term Unemployment (2015, methodology): “Recent research on inflation has also explored the roles of oil prices and consumer expectations (Coibion and Gorodnichenko, 2013); weak balance sheets of firms (Sim et al., 2013); and uncertainty about regional economic conditions (Murphy, 2014).”
Downside Variance Risk Premium (2015, neutral): “Gilchrist et al. (2014) meticulously study the behavior of this variable in 2007-2009 period.”
On DSGE Models (2018, neutral): “See, for example, Gilchrist et al. (2017) and Ottonello and Winberry (2017).”
Jump-Starting the Euro-Area Recovery: Would a Rise in Core Fiscal Spending Help the Periphery? (2015, neutral): “2015; Gilchrist et al. 2015), so that the Phillips curve slope could well be higher; in this case, the multiplier and spillovers would also be larger. On the other hand, our Calvo contract specification implies an immediate jump in both inflation and inflation expectations. But it is quite plausible”
The Slope of the Phillips Curve: Evidence from U.S. States (2020, background): “Our article is also related to a recent literature that assesses the missing disinflation during the Great Recession (see Christiano, Eichenbaum, and Trabandt 2015; Del Negro, Giannoni, and Schorfheide 2015; Gilchrist et al. 2017; Crump et al. 2019).”
Mending the broken link: Heterogeneous bank lending rates and monetary policy pass-through (2020, background): “…capital position and low sovereign bond exposure have a long-run pass-through greater than one may indicate that they strategically take advantage of their balance sheet position to expand their market share in the loan market (see e.g. Gilchrist et al., 2015, for a model with such features).”
Household Leverage and the Recession (2011, neutral): “The choice of transfers xt(s) is identical to that in (11) above, while total household consumption is given by (19) as earlier.”
The Aggregate Implications of Regional Business Cycles (2019, neutral): “http://www.econometricsociety.org/ Econometrica, Vol. 87, No. 6 (November, 2019), 1789–1833”
Financial Frictions and the Great Productivity Slowdown (2017, background): “However, since Gilchrist et al. (2017) show that financially constrained firms raised prices during the financial crisis, our results would be if anything, downward biased.”