Price Dynamics and Monetary Policy

• Applicant: Professor Dr. Volker Hahn
• Subject Area: Economic Policy, Applied Economics ; Economic Theory
• Term: since 2022
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 509916045

The proposed project consists of three parts. The first part of the project aims to enhance our understanding of the consequences of increases in market power for monetary non-neutrality, i.e. the degree to which nominal shocks have real effects, and for the dynamics of prices on goods markets. The starting point for this part of the project is the observation that there is a well-documented trend towards higher market power as measured by higher markups in goods markets in many countries. As new Keynesian models imply that markups are an important determinant of prices, this trend may be important for understanding the effects of monetary policy as well. According to our preliminary analysis, our model may be compatible with the flattening of the Phillips Curve that is observed by other authors. It may also provide a rationale for the finding that the frequency of price adjustment has decreased in the UK, when controlling for inflation. Moreover, we intend to examine whether increases in market power can help us understand the pattern that special prices, namely those ending with “00” and “50” are becoming increasingly prevalent in the UK. This trend may be particularly surprising because the literature has identified a desire to economize on change in payments as one major motive for choosing round prices like £2.00. With electronic means of payment becoming more widely used, this would suggest that the frequency of prices ending with “00” or “50” should decrease rather than increase.The second part of the project starts from a model with intertemporal productivity changes for workers and firms as well as sticky wages and prices. It examines the consequences of different trend inflation rates for different age groups and aggregate welfare. Studying the question of optimal inflation is important, as there is an ongoing debate about the optimal inflation target of central banks. The third part of the project constructs a menu cost model with a role for price points, where price points are prices like £2.00 that are chosen unusually frequently. The model serves to examine the degree of monetary non-neutrality and, in particular, to analyze the effects of monetary policy shocks. Moreover, it is intended to be used as a lab to study unconventional fiscal policy in the form of temporary changes in VAT rates. Temporary reductions in VAT rates have recently been used as a means of stimulating the economy in the UK in the aftermath of the worldwide financial crisis of 2007/2008 and in Germany during the ongoing COVID-19 crisis.

• DFG Programme: Research Grants