Decomposing inflation using micropricelevel data South Africas pricing dynamics

Inflation, or the general increase in prices, is the result of many unobserved adjustments. Only a fraction of prices change in a month. Some of those prices havent changed for over a year while others changed last month. Some are rising or falling faster than others. Some goods are on sale while others are not. These dynamics matter a lot in themselves as they describe pricing behaviour. But they also matter for economic theory forming the foundation of how these prices, and hence inflation, are predicted and forecast. We used a never-before analysed dataset of consumer goods prices to decompose inflation into the fraction of price changes (extensive margin), both increases and decreases, and the magnitude of those price changes (intensive margin). We found the following properties of pricing dynamics in South Africa. First, the average fraction or prices changing from 2009 to 2015 is 27.8 per cent, while the median change is only 12.5 per cent. The average fraction of prices changing per month can vary anywhere between 37 and 18 per cent. There is also substantial heterogeneity between products and over months. Second, the average magnitude of price changes 0.83 per cent, or just under 10 per cent annualised. Multiplying the extensive and intensive margins mean that monthly inflation averages 0.25 per cent, or 3.0 per cent annualised. Third, the variance in monthly inflation is explained mainly by the extensive margin, or the fraction of prices changing. This suggests that inflation in South Africa is state-dependent, rather than time-dependent. Fourth, the variance of inflation is mainly due to price increases (explains 70%). Fifth, sales prices account for only around four per cent of prices but help lower inflation from 4.8 per cent annualised to 3 per cent.