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Time-varying Price Flexibility and Inflation Dynamics

Author

Listed:
  • Petrella, Ivan

    (University of Warwick)

  • Santoro, Emiliano

    (University of Copenhagen)

  • Simonsen, Lasse P.

    (Birkbeck College)

Abstract

TWe 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 sizeable 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 P., 2019. "Time-varying Price Flexibility and Inflation Dynamics," EMF Research Papers 28, Economic Modelling and Forecasting Group.
  • Handle: RePEc:wrk:wrkemf:28
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    File URL: https://warwick.ac.uk/fac/soc/wbs/subjects/finance/mpf/working-papers/emf_wp_28.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    inflation ; price flexibility ; Ss models;
    All these keywords.

    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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