Repricing Avalanches

Abstract

We present a menu-cost pricing model with a large but finite number n of firms. A firm’s nominal price increase lowers other firms’ relative prices, thereby inducing further nominal price increases. The distribution of these “repricing avalanches” converges as 𝑛 → ∞ n → ∞ to a mixture of generalized Poisson distributions with an i n d e x o f d i s p e r s i o n = 1 / ( 1 − 𝜃 ) 2 index of dispersion = 1 / ( 1 − θ ) 2 , where θ is determined by the equilibrium of the continuous limit. We calibrate the model to the US experience during 1988–2005 and obtain a θ surprisingly close to unity. Our model accounts for the positive relationship between inflation level and volatility observed in the data.