Here’s The Economist:
A forthcoming paper by Diego Aparicio and Roberto Rigobon of the Massachusetts Institute of Technology helps make the point. Firms that sell thousands of different items do not offer them at thousands of different prices, but rather slot them into a dozen or two price points. Visit the website for h&m, a fashion retailer, and you will find a staggering array of items for £9.99: hats, scarves, jewellery, belts, bags, herringbone braces, satin neckties, patterned shirts for dogs and much more. Another vast collection of items cost £6.99, and another, £12.99. When sellers change an item’s price, they tend not to nudge it a little, but rather to re-slot it into one of the pre-existing price categories. The authors dub this phenomenon “quantum pricing” (quantum mechanics grew from the observation that the properties of subatomic particles do not vary along a continuum, but rather fall into discrete states).
I think that’s right, but I’m not sure about the implication that many observers draw from this practice:
Central banks are starting to see the consequences. Inflation does not respond to economic conditions as much as it used to. (To take one example, deflation during the Great Recession was surprisingly mild and short-lived, and after nearly three years of unemployment below 5%, American inflation still trundles along below the Federal Reserve’s target rate of 2%.) In its recently published annual report the Bank for International Settlements, a club of central banks, mused that quantum pricing and related phenomena help account for such trends.
But firms’ aversion to increasing prices may be as much a consequence of limp inflation as a contributor to it. . . .
I agree with that final sentence, but not so much with the preceding paragraph. Imagine a simple model where firms only changed prices when a 10% change was called for. Now assume that aggregate spending rises enough so that the overall equilibrium price level increases by 2%. In that case, roughly 20% of firms will now find themselves nudged into in a situation where a 10% price rise is called for. Each of those firms will raise prices by 10%, while the other 80% of firms don’t change prices at all. The price level rises by 2%. In that simple model, prices are very sticky at the firm level, but the overall price level is quite flexible.
That’s not to say there isn’t also some price level stickiness—I suspect there is. But I doubt this phenomenon explains the low inflation of recent years. A better explanation is the roughly 4% annual NGDP growth since 2009. That alone accounts for most of the roughly 1.6% inflation. If you want to argue that inflation would have been higher with more flexible prices, you’d also have to argue that real GDP growth would have been lower, if we hold NGDP growth at 4%. And real growth was already quite disappointing by historical standards.
In other words the surprising fact about the recovery is not so much the low inflation, it’s the low inflation combined with the low RGDP growth—in other words, low NGDP growth. I am confident that had NGDP growth averaged 5% or 6% during the recovery, inflation would have been higher and unemployment would have fallen more quickly. So while the sticky price theories are not wrong, they don’t tell us what’s truly important about the past decade.
READER COMMENTS
John Hall
Sep 6 2019 at 10:15am
At the end of the day, I keep hearing a huge amount of skepticism from people that central banks can do anything to raise inflation. More often than not, if I suggest 5% NGDP growth/level as a goal, the response is that the Fed or whoever is not able to do it. Now, I don’t believe that myself, but I think that’s probably one of the biggest arguments I see against NGDP targeting.
Also, on your point about 4% NGDP growth contributing to 1.6% inflation, I have heard you argue that 4% is a good target for NGDP growth/levels. Are you willing to revise that view?
Scott Sumner
Sep 6 2019 at 7:26pm
John, The growth rate over the past 10 years has been associated with a fall in unemployment from 10% to 3.7%. If we assume the unemployment rate will level off over the next ten years, then I’d expect slower RGDP growth going forward. Indeed I believe even 4% is probably too high to achieve the Fed’s 2% inflation target going forward.
But if we do adopt NGDP targeting, I’d be happy with any reasonable rate. The precise rate is not important with NGDP targeting, as 2% inflation is no longer the goal.
As for people who don’t believe the Fed can influence inflation/NGDP, they often have a flawed model of monetary policy in their heads, where low interest rates imply easy money.
Mark Z
Sep 8 2019 at 7:40pm
Maybe one could argue that most firms in an industry have similarly structured price slots, and so they’re mostly in the same boat when a <10% price increase happens in your example.
I don’t think even this would help the theory much though. It shouldn’t cause consistently stagnant prices; rather, it should cause punctuated equilibria. Prices should only be stagnant for a while before being jolted up once the precipice for a price increase is reached, then stagnant again until the next precipice. I don’t think that’s what’s being observed.
Scott Sumner
Sep 9 2019 at 9:33am
Yes, but there are thousands of industries, so the overall price level should be fairly smooth.
Gabe L Newell
Sep 24 2019 at 3:57am
Even if price points are sticky, products are not (e.g. chocolate bars vary weight to maintain price points, https://hersheyarchives.org/encyclopedia/hersheys-milk-chocolate-bar-wrappers-over-the-years/).
This is not a new problem, nor a macroeconomically interesting problem. Every consumer business routinely backsolves from price points to inputs (material quality and quantity, shipping and handling, labor costs, refund and return policies, etc…).
The authors are guilty of reasoning from a price.
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