Working Paper

Inflation Dynamics During the Financial Crisis


Abstract: Firms with limited internal liquidity significantly increased prices in 2008, while their liquidity unconstrained counterparts slashed prices. Differences in the firms' price-setting behavior were concentrated in sectors likely characterized by customer markets. We develop a model, in which firms face financial frictions, while setting prices in a customer-markets setting. Financial distortions create an incentive for firms to raise prices in response to adverse demand or financial shocks. These results reflect the firms' reaction to preserve internal liquidity and avoid accessing external finance, factors that strengthen the countercyclical behavior of markups and attenuate the response of inflation to fluctuations in output.

JEL Classification: E44; E31; E51; E32;

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File(s): File format is application/pdf http://dx.doi.org/10.17016/FEDS.2015.012
Description: http://dx.doi.org/10.17016/FEDS.2015.012

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2015-03-03

Number: 2015-12

Pages: 53 pages