Shifts in Australian Price-Setting Behaviour Around Large Shocks

The sharp rise in inflation following the COVID-19 pandemic has renewed interest in how firms adjust prices in response to large economic shocks and what this means for modelling inflation dynamics and setting monetary policy. Using a large dataset of web-scraped Australian retail prices, we document a decline in price rigidity and increase in the rate of price changes in 2022 and 2023, coinciding with a period of strong goods price inflation. We incorporate these microdata-based estimates of price-setting frequency into the RBA's DSGE model to assess their macroeconomic implications. We find that failing to account for the increase in the rate of price changes during the high inflation period could have led forecasters to underpredict inflation by up to 1.5 percentage points, even if they knew exactly which shocks were hitting the economy at the time. Moreover, lower price rigidity significantly steepened the Phillips curve, reducing the policy trade-off between inflation and output. Under these conditions, policymakers with the same preferences would tend to raise rates more aggressively (by up to around 40 basis points), compared to the case where rigidity did not change. Our findings highlight the importance of considering the implications of shifts in price-setting behaviour when analysing inflation outcomes and designing monetary policy.