Price Setting and Volatility: Evidence from Oil Price Volatility Shocks

Do changes in aggregate volatility alter the impulse response of output to monetary policy? I use plausibly exogenous oil price volatility shocks and exploit heterogeneity in oil usage across industries to show that PPI item-level price changes become less frequent and more dispersed when volatility is high. This implies aggregate price flexibility does not increase when aggregate volatility is high. I construct a state-dependent pricing model with random menu costs to interpret the findings. Matching the new empirical facts, the model shows that increases in aggregate volatility do not substantially reduce monetary policy effectiveness. (JEL E23, E31, E52, Q31, Q35)