Prices do not change continuously and are slow to adjust, according to research conducted by economists at the Bank of England, published in the February 2012 issue of the Economic Journal. This means that there is a role for monetary policy to affect the real economy, at least in the short run. The research also finds that prices change with different frequencies in different parts of the economy, implying that so-called ‘relative price effects’ – where movements in individual prices temporarily affect headline inflation – are present in the UK.
Price-setting behaviour plays a key role in the monetary transmission mechanism. Part of the reason why monetary policy may affect the real economy, at least in the short run, is that some prices adjust sluggishly. Typically, the economic models that are frequently used for monetary policy analysis assume that there are constraints on price adjustment. To find out how rigid prices are, the researchers looked at millions of individual price quotes and asked firms directly about how often they change their prices, as well as the reasons why prices may be sticky.
These studies analyse how often prices change in the UK and find that:
Differences in how often prices change across sectors and different types of products are typically ignored by most economic models. The researchers conclude that if those economic models are to match the stylised facts that we observe in the data, the challenge is to develop a new theory of price setting behaviour that is consistent with these facts whilst also fitting the properties of aggregate data.
Notes for editors: a special feature on 'New Insights into Price-Setting Behaviour in the United Kingdom' is published in the February 2012 issue of the Economic Journal. This consists of the following three articles:
'New Insights into Price-Setting Behaviour in the United Kingdom: Introduction and Survey Results' by Jennifer Greenslade and Miles Parker
'How Do Individual UK Producer Prices Behave?' by Philip Bunn and Colin Ellis
'Examining the Behaviour of Individual UK Consumer Prices' by Philip Bunn and Colin Ellis
Philip Bunn and Jennifer Greenslade are at the Bank of England, Colin Ellis is at the University of Birmingham and Miles Parker is at the Reserve Bank of New Zealand.
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