Euro area prices became more flexible during recent inflation surge
A Banco de España working paper reveals that consumer prices in the euro area became significantly more flexible during the 2021-2024 inflation cycle. The study, using micro data from nine countries, found that the frequency of price changes increased substantially, especially for energy-sensitive products.
Price changes surged to 12 percent monthly
The study, based on 190 million price quotes, found that the monthly frequency of consumer price changes in the euro area surged to 12 percent in 2022, a significant increase from the 8 percent average observed between 2010 and 2019. This frequency peaked at nearly 16 percent in January 2023 before gradually returning towards pre-pandemic levels in 2023 and 2024. The rise was primarily driven by a higher number of price increases, while the average magnitude of individual price adjustments remained largely stable.
Notably, the decline in price change frequency was slower for services, which remained elevated in 2024, compared to food and non-energy industrial goods.
Products with a larger share of imported-energy costs exhibited a stronger and more rapid response to the inflation surge, indicating a direct link between input costs and pricing behavior during the cycle.
State-dependent pricing amplified inflation
The paper supports state-dependent pricing models, where firms adjust prices more readily to larger shocks.
Hazard-rate evidence shows that the probability of price changes increases with the gap between actual and optimal prices, consistent with a steepening Phillips curve.
The study also decomposes inflation into extensive (frequency of changes) and intensive (magnitude of changes) margins.
During the recent surge, the extensive margin contributed more to inflation variation than in low-inflation periods.
A macroeconomic model suggests peak inflation would have been almost one percentage point lower if the frequency of price changes had not responded to the inflation surge.
A temporary but impactful shift
This research provides crucial empirical evidence on how firms adapted their pricing strategies during an unprecedented inflation shock.
While the increased flexibility was largely temporary, its impact on peak inflation was substantial, highlighting the importance of state-dependent pricing in monetary policy transmission.
Policymakers must now consider this dynamic when assessing future inflation risks and the effectiveness of their tools.