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Time-varying Price Flexibility and Inflation Dynamics

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  • Petrella, Ivan
  • Santoro, Emiliano
  • Simonsen, Lasse de la Porte

Abstract

We study how and to what extent inflation dynamics is shaped by time variation in the capacity of nominal demand to stimulate price adjustment. Using microdata underlying the UK consumer price index, we estimate a generalized Ss model of lumpy price adjustment, and condense large cross-sectional information on micro price changes into a measure of price flexibility. The latter displays sizable time variation, which maps into a marked non-linearity of inflation dynamics: the half-life of the rate of inflation is twice as large in periods of relatively low flexibility, along with appearing remarkably close to the one observed in a linear setting. Changes in firms' price-adjustment cost structure, as reflected in the adjustment hazard, are key to account for state dependence in price setting. Neglecting these facts may severely bias our understanding of inflation dynamics.

Suggested Citation

  • Petrella, Ivan & Santoro, Emiliano & Simonsen, Lasse de la Porte, 2018. "Time-varying Price Flexibility and Inflation Dynamics," CEPR Discussion Papers 13027, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13027
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    1. Huw Dixon & Kul Luintel & Kun Tian, 2020. "The Impact of the 2008 Crisis on UK Prices: What We Can Learn from the CPI Microdata," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 82(6), pages 1322-1341, December.

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    Keywords

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    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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