Inflation and Price Setting in a Natural Experiment

We analyse the behaviour of price setters in Poland during transition from a planned to a market economy, using a large disaggregated data set. The size of price changes and the frequency of adjustment both fall as the inflation rate declines. Price variability increases with inflation. The effect of expected inflation is much stronger than the effect of unexpected inflation. Price setters are forward looking and follow a mixture of state- and time-contingent policies. These results are broadly consistent with the menu cost model. The bottom line is this: it takes sellers of sausage, eggs, toothpaste, vacuum cleaners, car-wash operators etc. just a few years to figure out how to adjust prices in a market environment.