In‡ation and Price Adjustment: An Analysis of Microdata

I use large data sets on prices by products and stores from recent inflationary periods in Israel to compare simple menu cost models to simple uncertain and sequential trade (UST) models. The main empirical findings are: (a) Even in high inflation periods, price erosion due to inflation explains only a tiny fraction of the variation in non-zero nominal price changes; (b) There is an error correction type behavior in the choice of nominal prices: Stores which their last nominal price change was relatively low are likely to choose a nominal price change which is relatively high; (c) Stores that reduce their nominal price charge a lower price relative to store that increase their nominal price and (d) Relative price variability is not related to inflation. I argue that these findings are not consistent with simple menu cost models but are consistent with a simple UST model. I have benefited greatly from the comments of Eyal Baharad