Inflation Dynamics and Price Flexibility in the UK


Inflation Dynamics and Price Flexibility in the UK

Research Seminar

Tuesday 29 May 2018, 16:30 — 17:30

Presented by: Ivan Petrella, Warwick Business School

with Emiliano Santoro (University of Copenhagen) and Lasse de la Porte Simonsen (Birkbeck College)

National Institute of Economic and Social Research, 2 Dean Trench Street, Smith Square, London SW1P 3HE

Using microdata underlying the UK consumer price index we document how the distribution of price changes has evolved over the last two decades and how its variation reflects into the dynamics of price flexibility. In the period after the Great Recession the dispersion of price changes has displayed a sustained upward trend, while the frequency of adjustment has dropped. We rationalize these facts within a stylized menu cost model, showing that a persistent increase in the inaction to nominal shocks may be compatible with the observed diverging trends. We support this prediction by estimating a generalized Ss model. Price flexibility displays pronounced time variation. In fact, over the last decade the capacity of nominal stimulus to generate inflation has decreased substantially. Despite the marked non-linearity of inflation dynamics dictated by changes in the degree of price flexibility, we show that neither the Bank of England nor professional forecasters seem to account for this type of state dependence when forming inflation expectations. In fact, they both tend to overestimate inflation persistence in periods of relatively high price flexibility, especially at medium-term forecast horizons.

Ivan Petrella is an Associate Professor in the Economic Modelling and Forecasting Group at Warwick Business School. He’s interested in Macroeconomics, Monetary Policy and Applied Econometrics. Prior to his appointment at WBS, he was a senior economist at the Bank of England and senior lecturer at Birkbeck College, University of London. Ivan holds a PhD in Economics from the University of Cambridge.