New Insights into Price-setting Behaviour in the United Kingdom

Prices do not change continuously and are slow to adjust, according to research conducted by economists at the Bank of England, published in the February 2012 issue of the Economic Journal. This means that there is a role for monetary policy to affect the real economy, at least in the short run. The research also finds that prices change with different frequencies in different parts of the economy, implying that so-called ''relative price effects'' – where movements in individual prices temporarily affect headline inflation – are present in the UK.

Price-setting behaviour plays a key role in the monetary transmission mechanism. Part of the reason why monetary policy may affect the real economy, at least in the short run, is that some prices adjust sluggishly. Typically, the economic models that are frequently used for monetary policy analysis assume that there are constraints on price adjustment. To find out how rigid prices are, the researchers looked at millions of individual price quotes and asked firms directly about how often they change their prices, as well as the reasons why prices may be sticky.

These studies analyse how often prices change in the UK and find that:

  • Using over 11 million price quotes that underpin the official CPI data between 1996 and 2006, around one-fifth of consumer prices change each month.
  • UK consumer prices change slightly less often than in the US, but more frequently than in the euro area.
  • A database of 5 million price quotes from UK supermarket till receipts, suggests prices in supermarkets change more often than other retail prices. But even using these data, price changes are not happening continuously.
  • Around a quarter of producer prices – the prices at which manufacturing companies sell their output – change each month.
  • There are considerable differences in the behaviour of prices across sectors and different types of items. For example, goods prices change three times as often as services prices. Petrol prices are the consumer prices found to change most often, with around two-thirds of the prices sampled changing each month.
  • And there is variation in how often prices change over time, from year to year and month to month. Prices change most often in January, because of sales, and least often in November and December.
  • Surveys of firms can provide a useful cross-check on estimates of how often prices change. New survey evidence suggests that around one fifth of UK companies change prices at least monthly, whereas one third of firms change prices annually.
  • In the survey, firms said that the most important explanations for why prices are sticky are: contracts with customers; a desire not to antagonise customers (in the case of price increases); and a desire not to raise prices before competitors.

Differences in how often prices change across sectors and different types of products are typically ignored by most economic models. The researchers conclude that if those economic models are to match the stylised facts that we observe in the data, the challenge is to develop a new theory of price setting behaviour that is consistent with these facts whilst also fitting the properties of aggregate data.

A special feature on ''New Insights into Price-Setting Behaviour in the United Kingdom'' is published in the February 2012 issue of the Economic Journal. This consists of the following three articles:

''New Insights into Price-Setting Behaviour in the United Kingdom: Introduction and Survey Results'' by Jennifer Greenslade and Miles Parker

''How Do Individual UK Producer Prices Behave?'' by Philip Bunn and Colin Ellis

''Examining the Behaviour of Individual UK Consumer Prices'' by Philip Bunn and Colin Ellis

Philip Bunn and Jennifer Greenslade are at the Bank of England, Colin Ellis is at the University of Birmingham and Miles Parker is at the Reserve Bank of New Zealand.