Price Setting during Low and High Ination: Evidence from Mexico

This paper provides new insight into the relationship between in‡ation and consumer price setting by examining a large data set of Mexican consumer prices covering episodes of both low and high in‡ation, as well as the transition between the two. The overall portrait is one in which the economy shares several characteristics of time dependent models when the annual in‡ation rate is low (below 10-15%), while displaying strong state dependence when in‡ation is high (above 10-15%). At low in‡ation levels, the aggregate frequency of price changes responds little to movements in in‡ation because movements in the frequency of price decreases partly o¤set movements in the frequency of price increases. When the annual in‡ation rate is above 10-15 percent, however, there are no longer enough price decreases to counterbalance price increases, making the frequency of price changes much more responsive to in‡ation. In this case, a 1-percent increase in the annual in‡ation rate is associated with a 0.40-0.45-percentage-points increase in the monthly frequency of price changes for consumer goods. JEL classi…cation: E31, D40, C23.