I study the relative importance of domestic frictions and border price insensitivity for the response of domestic consumer prices (CPI) to exchange rate fluctuations. Using firm and transaction-level data from Chile, I estimate that the presence of domestic frictions --- distribution costs, variable markups and nominal rigidities --- reduce the responsiveness of domestic CPI to exchange rate fluctuations by 60% relatively to an economy that abstract away from it. These frictions are quantitatively more important than the insensitivity of border prices. The presence of domestic frictions also matters for the channels of CPI sensitivity: contrary to prior work, most of the sensitivity arises from the change in the price of imported consumption goods. This channel is more important than the costs arising from imported inputs in the production of domestic goods. The reason is that domestic frictions dampen the price sensitivity of domestically produced goods relatively more. Furthermore, the sensitivity varies across products because of the heterogeneity in domestic frictions, import exposure, and consumption shares. The heterogeneity matters for the overall (in)sensitivity as domestic products with higher import exposure face larger frictions and have lower consumption shares. Ignoring the heterogeneity identifies the wrong products from which most of the sensitivity arises, with implications for monetary policy targeting in open economy and redistribution dynamics.

Lack of detailed data on product characteristics and quality change poses a challenge for the accurate aggregation of changes in the real volumes of consumption, production, and trade flows. To tackle this problem, we propose a method that allows us to identify demand and infer unobserved quality change using data only on prices and market shares, without the need for external cost shock instruments or strong assumptions on the covariance between supply and demand shocks. We also characterize the contribution of changes in quality, price, and variety entry/exit to the aggregate price index for general invertible demand systems, generalizing the standard results derived in the CES case. We apply our strategy to compute the US import price index based on the Kimball demand, allowing for heterogeneity in substitutability across products. We find that quality change on average lowers the inflation in import prices by around 0.7% annually. To further validate our approach, we show that it estimates price elasticities and quality changes similar to those found by the standard mixed logit (BLP) demand in data on the US auto market, without relying on the information on product characteristics and price instruments.

We study how the exchange rate dynamics are influenced by the presence of heterogeneous investors with varying degrees of price impact. Leveraging data from the U.S. Commodity Futures Trading Commission (CFTC) on investors’ currency positions, we show that foreign exchange rate markets display a significant level of concentration, and investors’ price impact is stronger in more concentrated markets. We develop a monetary model of exchange rate determination that incorporates heterogeneous investors with different degrees of price impact. We show that the presence of price impact amplifies the exchange rate’s response to non-fundamental shocks while dampening its response to fundamental shocks. As a result, investors’ price impact contributes to the disconnect of exchange rates from fundamentals and the excess volatility of exchange rates. We provide empirical evidence in line with our theoretical predictions, using data on trading volume concentration from the US CFTC foreign exchange rate market for 10 currencies spanning from 2006 to 2016. Additionally, we extend our framework to account for information heterogeneity among investors, which presents a competing dimension of heterogeneity with qualitatively similar implications for exchange rate dynamics. Both dimensions of heterogeneity are quantitatively relevant, with the heterogeneity in price impact accounting for 62% of the additional volatility and 35% of the additional disconnect attributed to investors’ heterogeneity.

Managers face continuous pressure to meet short-term forecasts and targets, which can potentially impact firms’ investments in customer capital and pricing decisions. Using data on U.S. public companies together with IBES analysts’ forecasts, we find that firms that just meet analysts’ profit forecasts have an average markup growth of 0.8% higher than firms that just miss targets, suggesting opportunistic markup manipulation. To assess the aggregate economic implications of short-termism, we develop and estimate a quantitative firm-heterogeneity model that incorporates short-term frictions and endogenous markups resulting from customer accumulation. In the model, short-termism arises optimally to offset manager’s private incentives, resulting in higher markups and lower customer capital stock. We find that, on average, firms increase markups by 8% due to short-termism, generating $38 millions of additional annual profits. At the macro level, the distortion reduces consumers’ welfare by 4% and lowers the annual total market capitalization by $3.1 trillions on average.

This paper studies how large global shocks can undermine the dominance that the US dollar plays in the international monetary system. We show that, following the Great Financial Crisis and the temporary increase in the cost of US dollar financing, the share of total Chilean imports denominated in US Dollar (Chilean Peso) steadily decreased (increased) by almost 10\% (7\%) by the end of 2019, while no changes in the invoicing patterns took place on the exports side. Using the Chilean universe of international transactions from 2007 to 2019, we study the firm-level determinants of these aggregate patterns. We show that: i) the bulk of changes in aggregate invoicing shares is due to firms switching from US dollar to Chilean Peso, as opposed to reallocation between firms or firm entry; ii) the first importers to switch to Chilean Peso invoicing are large firms with wider US Dollar currency mismatches, suggesting that both natural hedging and strategic complementarities are relevant in shaping invoicing choices. We rationalize these findings with a currency choice model of an economy populated by importing firms that choose the currency of denomination of their trade credit for imported inputs, in the presence of natural hedging and strategic complementarities motives. We show how the introduction of sunk cost of currency management generates hysteresis in invoicing choices, yielding permanent changes in the aggregate invoicing share following a temporary shock in the cost of trade credit. Lastly, we test the key theoretical mechanism and study the implications of large changes in invoicing patterns for the whole macroeconomy.

The heterogeneous sensitivity of firms to aggregate fluctuations influences the dynamics of the business cycle. We study how firms’ outcomes (sales, debt, investment, and market value) respond to aggregate fluctuations (business cycle, monetary policy, uncertainty, and oil shocks) based on eight observed characteristics using the Generalized Random Forest algorithm. Using micro-level data from Compustat, we document three micro-facts about the cross-sectional heterogeneity in firm sensitivity: (1) while the linear OLS benchmark provides good estimates of the average effect, there is significant cross-sectional heterogeneity in firms’ sensitivities; (2) the importance of firm characteristics varies across dependent variables and shocks, but on average, non-financial characteristics play a larger role in explaining the heterogeneity in sensitivity; (3) sensitivity to aggregate fluctuations exhibits non-linear patterns with respect to firms’ characteristics. We study the implications of cross-sectional heterogeneity in firm-level sensitivity, developing an aggregation theory and leveraging the estimated random forest model to generate counterfactual firm-level sensitivities. We show that: (1) the heterogeneity in sensitivity amplifies the aggregate response to macroeconomic variables; (2) the impact of estimated non-linearity at the micro-level on the aggregate response is negligible; (3) non-financial characteristics shape aggregate responses more than financial characteristics; and (4) state-dependent heterogeneity in firm characteristics plays a marginal role in driving the aggregate response to macroeconomic variables.