Pricing-to-market in business cycle models

Abstract

We evaluate several leading microfounded pricing-to-market (PTM) mechanisms embedded in a two-country DSGE model with volatile exchange rates driven by real and financial shocks. Across these frameworks, including the reduced-form Kimball specification, we identify a fundamental parameterization trilemma: models typically struggle to simultaneously match empirically plausible producer markups, muted expenditure switching (low short-run trade elasticity), and the low exchange-rate pass-through needed to account for the business-cycle dynamics of prices and quantities. We provide an analytical characterization of this trilemma and quantitatively assess each model’s performance vis-à-vis a unified set of empirical benchmarks.