Last week in "Jackson Hole Stars Today....", I wrote that it would be interesting to see if a new interpretive model for 'gig-economy' inflation starts to emerge, and the changing role inflation might play in setting monetary policy.

Well, the first part did emerge, in the form of a paper entitled: “More Amazon Effects: Online Competition and Pricing Behavior,” by Alberto Cavallo of Harvard Business School; and which was adeptly responded to by Yuriy Gorodnichenko of UC Berkeley.

Key points (which I paraphrase) from the response:

1. Amazon’s prices are a lot more flexible than prices of conventional, brick-and-mortar stores, forcing Walmart (and presumably other traditional retailers) to adjust prices more often for products that are also offered on Amazon.com.

2. As result, via strategic complementarity, Amazon.com can have more influence on how prices are set than is suggested by Amazon.com’s market share. This means that consumer prices may be more sensitive to cost shocks than thought before.

3. While traditional retailers have some scope for variation of prices across geographical locations (i.e., a bottle of Pepsi may cost more in New York than in Detroit), online stores effectively offer the same price across locations thus pushing uniform pricing to the extreme.

In relation to why Central Banks should care about Cavallo's analysis, Gorodnichenko concludes with the following.

"Walmart reshaped the landscape of retail in the 1980s and 1990s. Now a new revolution in retail is being led by Amazon, Ebay, Overstock and other online shops. In this new world, menu costs are negligible, search for best prices is cheap and easy, and the geographical location of consumers and stores is largely irrelevant. Undoubtedly, these characteristics of e-commerce will make prices more flexible and more uniform across locations, although consumer prices will not converge in their properties to commodity prices. What does this mean for central banks?

My tentative analysis suggests several predictions. First, monetary policy should be more aggressive in combatting recessions. Second, central banks should likely put a higher weight on volatility of output as more flexible prices lead to smaller distortions in the allocation of resources. Third, holding everything else constant, inflation will likely become more volatile and cyclically sensitive, more dominated by transitory shocks, and potentially move difficult to control in the short run. Fourth, central banks will possibly need to redefine their targets and operations to respond to the evolving nature of price setting in the retail sector. Perhaps, central banks will need to develop new tools to make their policies more targeted.

Of course, these changes will not happen overnight but central banks will be well advised to prepare themselves early on. Indeed, despite the growing importance of e-commerce, the properties of online prices are still relatively understudied. Somewhat surprisingly, efforts to collect online price data are largely confined to individual academics like Alberto but this kind of endeavor requires considerable investment and institutional support. Since statistical agencies appear to show little appetite to gather price quotes and volumes of sales for e-commerce, central banks should fill in this void. Having such data will help us better understand the nature of online markets and adjust policies accordingly."

I think we will see more comments about changing retail shopping pricing behaviour, uniform pricing being more potent in areas of high unemployment, a flatter Philips Curve, perhaps a new focus on volatility of output instead of price, and the e-commerce or "Amazon Effect' fundamentally lowering inflation as a result of the factors in Cavallo's report.

To me, this means Central Banks should focus less on inflation when setting monetary policy - either that, or take out the 'Amazon Effect'. Gorodnichenko suggests putting a higher weight on volatility of output, as opposed to prices - and that's smart. Needless to say if you adopt this view, you should also be adopting the view that low inflation in the post-Amazon era should not be a key reason to keep interest rates low.

Let's all chew on that as more analysis is undertaken over the next 12 months.

Mike

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