Mark Gertler Publications

We derive an aggregate state-space representation of state-dependent pricing models with random menu costs and strategic complementarities. The representation, derived from first principles, replaces the cross-sectional distribution of price gaps with a finite set of its moments (the first three), while preserving the key economic forces of state-dependent pricing–movements in the frequency of price adjustment and selection. Along the impulse response, inflation is an odd (cubic) polynomial in the average price gap. Embedded in a general equilibrium setting, the model can be solved by perturbation, filtered, and estimated with standard DSGE tools, and it matches well the global solution across shock sizes. Applied to the 2021–22 inflation surge in the United States and the euro area, it shows that much of the variation that linear models would attribute to cost-push shocks is in fact endogenous amplification through the frequency of price changes and selection.

We develop a unified approach to studying cost-price dynamics in the cross-section of firms in order to jointly explain the time series of aggregate inflation and the frequency of price changes, both during normal times and inflation surges. A key novelty is the use of microdata on firms’ prices and production costs to construct an empirical measure of price gaps—the deviation between a firm’s listed and optimal price. Conditional on the path of aggregate cost shocks extracted from the data, a state-dependent pricing model with strategic complementarities accounts well for both the linear cost-price dynamics of the pre-pandemic period and the nonlinear increase in inflation and frequency of price adjustment that followed.