RDP 2026-02: Shifts in Australian Price-setting Behaviour around Large Shocks 7. Conclusion

Our analysis shows that the large supply shocks of the late pandemic period coincided with a decline in price rigidity, as firms became more willing to adjust prices. This shift contributed meaningfully to the sharp rise in inflation in 2022 and 2023.

The observed tendency for price rigidity to decline during large shocks has important implications for macroeconomic modelling and policy. First, inflation may accelerate more rapidly than predicted by standard linear models, requiring forecasters – including central banks – to account for more flexible price-setting behaviour. Second, as rigidity falls, the Phillips curve steepens, reducing the trade-off between inflation and output. This means that, all else equal, central banks facing large supply-side inflationary shocks can raise interest rates more aggressively and achieve inflation objectives more quickly, with limited additional costs to economic activity.

Applying these insights in real time is challenging. Prices microdata are not currently available on a timely basis in many countries, including Australia, and the nature of shocks during turbulent periods can be difficult to identify. Policymakers must therefore rely on informed judgement to assess whether firms are adjusting prices more frequently. Business liaison and business surveys may offer valuable real-time signals in these periods.

Accurate identification of the type of shock hitting the economy is also critical. The policy implications we describe for periods of lower price rigidity are most relevant for supply-side shocks, where inflation and output move in opposite directions. In contrast, demand shocks typically push both inflation and output in the same direction, making the policy trade-off less relevant. This underscores the importance of robust shock identification, as discussed in Beckers, Hambur and Williams (2023).

One way to improve forecasting accuracy under shifting price-setting behaviour is to expand the set of models used in policy analysis. Models with state-dependent pricing allow firms' responsiveness to vary with the size of economic shocks and can be calibrated using empirical moments from microdata – such as those estimated in this paper.

In the absence of timely data or formal models that explicitly capture changing rigidity, policymakers must lean more heavily on informed assessment. In these instances, the findings in this paper offer an intuitive evidence-based guide to how price-setting behaviour is likely to evolve during large supply shocks and how these changes affect inflation dynamics and the design of monetary policy responses.