ECB Economic Bulletin Pre-Release: Inflationary Shocks Drive Frequency of Price Changes

24 April 2024

By Aurėja Bobelytė – VILNIUS (Econostream) – The frequency of price changes was found to increase in the context of large inflationary shocks, according to an Economic Bulletin paper pre-released by the European Central Bank on Wednesday.

‘The larger a shock to nominal costs, the more firms will experience misaligned prices and decide to change them, driving up the aggregate frequency of price adjustment’, the paper said.

The Price-setting Microdata Analysis Network found that when the underlying cost shocks persisted at a certain level, inflation would increase faster than in a scenario where the frequency of price changes stayed the same.

‘At the same time, the pass-through of the shocks to the aggregate price level will be faster and inflation will return to the central bank’s target more quickly’, the paper added.

According to the paper, state dependent pricing in the euro area had significant implications for inflation dynamics and monetary policy transmission, particularly in high-inflation environments.

‘In a high-inflation environment characterised by large shocks, the empirical implications of state-dependent pricing for inflation dynamics and the transmission of monetary policy are even more pronounced.’, the paper said.

After firms have adapted to the major cost shock by adjusting their prices, state dependence suggested that the frequency of changing prices would go back to its long-term norm, the ECB commented.

As price flexibility returned to its pre-shock levels, any decline in aggregate demand could slow economic activity instead of reducing inflation, as fewer firms would choose to lower prices, the ECB noted.

[I]n the absence of further large shocks, the transmission of monetary policy should, all else being equal, more closely reflect the historical patterns prevailing in the pre-pandemic period of stable inflation’, the paper said.

‘For any given change in monetary policy stance, either contractionary or expansionary, its effects on inflation should materialise with lags similar to those seen before the pandemic’, the ECB said.