Price-setting behaviour in the Czech Republic (micro data evidence) in relation to the pricing mechanism in the g3 forecasting model

The aim of the analysis presented in this box is to obtain information about changes in the prices of consumer basket items. That information is subsequently compared with how the pricing mechanism is set in the microeconomic foundations of the g3 core forecasting model.

The frequency, seasonality and average size of the changes in prices, the average length of the period of unchanged prices and other characteristics were assessed using detailed data on prices monitored in the CZSO’s consumer price survey. Data on prices of selected items of the consumer basket were available at the level of individual reporting agents (retail outlets) at monthly frequency over the period 2001–2005. Average annual headline inflation was 2.3% in this period.

The average price change frequency of all the selected items was 0.26. This means that roughly one in every four prices was changed compared to the previous month (see Tables 1 and 2). The frequency of price increases was 0.16 and the frequency of price decreases was 0.10. The average price change was around 10%. For the individual subcategories of the consumer basket, the lower the price change frequency, the larger the average price change. The average length of the period of unchanged prices for all the selected items was 10.7 months.

The analysis reveals that administrative prices mostly only go up, usually doing so sharply at the start of the year. Unprocessed food has a higher price change frequency than processed food, owing to the volatility of agricultural commodity prices. Prices of tradables excluding food and fuels decreased continuously throughout the period under review and had a low price change frequency. Non-tradable unregulated prices steadily increased, and this subcategory, with the exception of hypothetical rents and prices of package holidays, recorded the lowest price change frequency. By contrast, hypothetical rents and prices of package holidays had a high frequency of change. Fuel prices changed most frequently, but their individual changes were the smallest of the categories under review on average. Fuel prices respond relatively quickly to changes in prices of raw materials and the koruna exchange rate, so they change to a lesser extent but frequently.

The g3 forecasting model also works with the fact that retailers change their prices only after a certain period of time has elapsed (see the box Pricing in the g3 model in Inflation Report IV/2008). This price rigidity is captured in the model by assuming that each company can change the prices of its products in a given quarter with a certain probability only. The actually observed price rigidity can be simulated very well using this mechanism, and for this reason it is one of the core elements of most macroeconomic models currently used in practice. Given the settings of the g3 model, firms in the model economy change their prices every three quarters on average. This mechanism models net inflation only, whereas the stickiest regulated prices are inserted into the forecast by expert judgement, so this value is in line with the above statistics. Similar settings are used in other comparable models and are confirmed by estimates based on data using Bayesian methods.

Table 1 (Box) Changes in prices of consumer basket items
Fuel prices changed most frequently

Table 2 (Box) Changes in prices of consumer basket items The average length of the no price change period was 10.7 months