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What do sticky and flexible prices tell us?

Author

Listed:
  • Millard, Stephen

    () (Bank of England)

  • O'Grady, Tom

    () (Massachusetts Institute of Technology)

Abstract

In this paper, we investigate the information content of prices in relatively sticky-price sectors versus relatively flexible-price sectors. We first present some empirical evidence that relatively flexible prices react more to deviations of output from trend than stickier prices and that sticky prices can tell us about firms’ inflation expectations. We then develop a simple DSGE model with a sticky-price sector and a flexible-price sector and use this model to show that these empirical results are exactly what you would actually expect to see, given standard economic theory. Taken together, the results of this paper suggest that calculations of ‘flexible-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the output gap, which is notoriously hard to measure, and that calculations of ‘sticky-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the medium-term inflation expectations of price-setters.

Suggested Citation

  • Millard, Stephen & O'Grady, Tom, 2012. "What do sticky and flexible prices tell us?," Bank of England working papers 457, Bank of England.
  • Handle: RePEc:boe:boeewp:0457
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2012/what-do-sticky-and-flexible-prices-tell-us.pdf
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    References listed on IDEAS

    as
    1. Huw Dixon & Hervé Le Bihan, 2012. "Generalised Taylor and Generalised Calvo Price and Wage Setting: Micro‐evidence with Macro Implications," Economic Journal, Royal Economic Society, vol. 122(560), pages 532-554, May.
    2. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    3. Kara Engin, 2011. "Micro-Data on Nominal Rigidity, Inflation Persistence and Optimal Monetary Policy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-19, July.
    4. Richard Mash, 2004. "Optimising Microfoundations for Inflation Persistence," Economics Series Working Papers 183, University of Oxford, Department of Economics.
    5. Barnett, Alina & Macallan, Clare & Pezzini, Silvia, 2010. "Public attitudes to inflation and monetary policy," Bank of England Quarterly Bulletin, Bank of England, vol. 50(2), pages 115-123.
    6. Engin Kara & Huw Dixon, 2005. "Persistence and Nominal Inertia in a Generalized Taylor Economy: How Longer Contracts Dominate Shorter Contracts," Computing in Economics and Finance 2005 87, Society for Computational Economics.
    7. Altissimo, Filippo & Mojon, Benoit & Zaffaroni, Paolo, 2009. "Can aggregation explain the persistence of inflation?," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 231-241, March.
    8. Philip Bunn & Colin Ellis, 2012. "How do Individual UK Producer Prices Behave?," Economic Journal, Royal Economic Society, vol. 122(558), pages 16-34, February.
    9. Kevin D. Sheedy, 2007. "Inflation Persistence When Price Stickiness Differs Between Industries," CEP Discussion Papers dp0838, Centre for Economic Performance, LSE.
    10. Huw Dixon & Engin Kara, 2010. "Can We Explain Inflation Persistence in a Way that Is Consistent with the Microevidence on Nominal Rigidity?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(1), pages 151-170, February.
    11. Cagliarini, Adam & Robinson, Tim & Tran, Allen, 2011. "Reconciling microeconomic and macroeconomic estimates of price stickiness," Journal of Macroeconomics, Elsevier, pages 102-120.
    12. Maćkowiak, Bartosz & Moench, Emanuel & Wiederholt, Mirko, 2009. "Sectoral price data and models of price setting," Journal of Monetary Economics, Elsevier, vol. 56(S), pages 78-99.
    13. Sheedy, Kevin D., 2010. "Intrinsic inflation persistence," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 1049-1061, November.
    14. Carvalho Carlos, 2006. "Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(3), pages 1-58, December.
    15. Michael F. Bryan & Brent Meyer, 2010. "Are some prices in the CPI more forward looking than others? We think so," Economic Commentary, Federal Reserve Bank of Cleveland, issue May.
    16. Greenslade, Jennifer & Parker, Miles, 2010. "New insights into price-setting behaviour in the United Kingdom," Bank of England working papers 395, Bank of England.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Flexible-price inflation and monetary policy
      by Economic Logician in Economic Logic on 2012-08-10 19:25:00
    2. [経済]ある価格は他の価格よりも硬直的である
      by himaginary in himaginaryの日記 on 2012-08-10 12:00:00
    3. The macroeconomic challenge
      by ? in Stumbling and Mumbling on 2014-02-19 20:07:00

    Citations

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    Cited by:

    1. Ádám Reiff & Judit Várhegyi, 2013. "Sticky Price Inflation Index: An Alternative Core Inflation Measure," MNB Working Papers 2013/2, Magyar Nemzeti Bank (Central Bank of Hungary).
    2. Choi, Chi-Young & O'Sullivan, Róisín, 2013. "Heterogeneous response of disaggregate inflation to monetary policy regime change: The role of price stickiness," Journal of Economic Dynamics and Control, Elsevier, vol. 37(9), pages 1814-1832.
    3. Franz Ruch & Neil Rankin & Stan du Plessis, 2016. "Working Paper – WP/16/06- Decomposing inflation using micro-price-level data- South Africa’s pricing dynamics," Papers 7353, South African Reserve Bank.

    More about this item

    Keywords

    Flexible-price inflation; sticky-price inflation; heterogeneous price-setting;

    JEL classification:

    • B30 - Schools of Economic Thought and Methodology - - History of Economic Thought: Individuals - - - General
    • B40 - Schools of Economic Thought and Methodology - - Economic Methodology - - - General

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