Linking Individual and Aggregate Price Changes

This paper studies the implications of lumpiness and heterogeneity in microeconomic pricing decisions for dynamics in price aggregates. To capture the latent deviation between actual and target prices, it develops a semi-structural empirical model of two-sided (S,s) price setting. Applying the model to a unique panel of store level retail prices reveals that fluctuations in the shape of cross-sectional price deviation densities contain extra information on aggregate price change dynamics. Asymmetry in the density particularly matters. Idiosyncratic shocks magnify the size, but do not alter the direction of aggregate fluctuations. When the target price is proxied by the cross-store mean price, the link between inflation and the price deviation density disappears.