Working Paper No. 457
By Stephen Millard and Tom O’Grady
In this paper, we investigate the information content of prices in relatively sticky-price sectors versus relatively flexible-price sectors. We first present some empirical evidence that relatively flexible prices react more to deviations of output from trend than stickier prices and that sticky prices can tell us about firms’ inflation expectations. We then develop a simple DSGE model with a sticky-price sector and a flexible-price sector and use this model to show that these empirical results are exactly what you would actually expect to see, given standard economic theory. Taken together, the results of this paper suggest that calculations of ‘flexible-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the output gap, which is notoriously hard to measure, and that calculations of ‘sticky-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the medium-term inflation expectations of price-setters.
What do sticky and flexible prices tell us?