Price Setting During Low and High Inflation: Evidence from Mexico

59 Pages Posted: 11 Jul 2007

See all articles by Etienne Gagnon

Etienne Gagnon

Board of Governors of the Federal Reserve System

Date Written: May 2007

Abstract

This paper provides new insight into the relationship between inflation and consumer price setting by examining a large data set of Mexican consumer prices covering episodes of both low and high inflation, as well as the transition between the two. Overall, the economy shares several characteristics with time-dependent models when the annual inflation rate is low (below 10-15%), while displaying strong state dependence when inflation is high (above 10-15%). At low inflation levels, the aggregate frequency of price changes responds little to movements in inflation because movements in the frequency of price decreases partly offset movements in the frequency of price increases. When the annual inflation rate rises beyond 10-15 percent, however, there are no longer enough price decreases to counterbalance the rising occurrence of price increases, making the frequency of price changes more responsive to inflation. It is shown that a simple menu-cost model with idiosyncratic technology shocks predicts remarkably well the level of the average frequency and magnitude of price changes over a wide range of inflation.

Keywords: price setting, consumer prices, frequency of price changes, time-dependent pricing, state-dependent pricing

JEL Classification: E31, D40, C23

Suggested Citation

Gagnon, Etienne, Price Setting During Low and High Inflation: Evidence from Mexico (May 2007). FRB International Finance Discussion Paper No. 896. Available at SSRN: https://ssrn.com/abstract=998840 or http://dx.doi.org/10.2139/ssrn.998840

Etienne Gagnon (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States
2024523522 (Phone)

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