Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Frequency and Costs of Individual Price Adjustment

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Frequency and Costs of Individual Price Adjustment

Article excerpt

The concept of "sticky prices" has been one of the most common explanations for the perceived importance of monetary policy since at least as far back as the 1930s. Simply put, if nominal prices for individual goods do not continuously adjust to economic conditions, then it is natural to think that monetary policy can influence the level of real economic activity through its ability to determine the nominal quantity of money. In evaluating whether this channel for monetary policy is important, two sets of research questions are relevant. First, do individual prices indeed change infrequently, and if so, why? Second, within macroeconomic models, what are the aggregate implications of the pricing behavior found in the data, and are those implications consistent with aggregate economic data? This article reviews research on the first set of questions in the hope of deriving lessons useful for improving the macroeconomic models that can address the second set.'

Weiss (1993) and Wynne (1995) have written surveys on similar topics. Weiss promotes the importance of infrequent price adjustment, whereas Wynne is a skeptic. This article differs from their work in that it covers the many papers that have appeared since 1995 and provides a history of thought perspective on theories of infrequent price adjustment. Much of my previous research has involved sticky price models, so I have a stake in what the evidence reveals.

Research on price stickiness has involved continual interplay between theory and empiricism. The early empirical studies discussed below approach "pure" empirical exercises. Research was not conducted in a vacuum, but these studies seem to have only broad theoretical motivation, and-initially-- the results were not used to support particular theories. Subsequent theories of pricing behavior were developed and refined; the theory of explicit "menu" costs of price adjustment has been most sharply refined. Most of the empirical work I survey was conducted with this theory as its organizing framework. However, I also describe recent empirical work that takes a more naive approach, studying the pricing process at a large industrial firm. Together with two surveys of firms' pricing behavior, this recent work relates to several less-- refined theories of infrequent price adjustment. Table 1 lists the empirical studies I survey.

Prices do change infrequently for many retail transactions. Furthermore, price adjustment behavior appears to be consistent with explicit, direct costs of changing prices. Evidence of infrequent price changes also exists for nonretail transactions, but the costs associated with price adjustment are not as easy to pin down. New evidence, supplementing years of conjecture, suggests that these costs involve the repeated nature of many buyer-seller relationships. The main challenges ahead are to improve both measurement, so that we better understand the nature of buyer-seller relationships, and theory, to study the macroeconomic implications of such relationships. It is not clear that conclusions about monetary policy based on direct costs of price change will carry over to models where infrequent price change results partly from repeated relationships.

1. MILLS'S DATA AND "ADMINISTERED PRICES"

Frederick Mills (1927) published what may be the first study of the frequency of price changes. He documented the behavior of wholesale price quotations for more than two hundred goods, using data from the Bureau of Labor Statistics' wholesale price bulletins covering the period from 1890 to 1926. The broad range of goods in Mills's book makes it a valuable source: he covers everything from cotton yam ("Carded, white, mulespun, northern, cones, 10/1") to doorknobs ("Steel, bronze-plated"). A drawback to Mills's data, however, is that it is stated at a monthly frequency, with the monthly observations either taken one day per month or as an average of daily or weekly observations. …

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