Staff Working Paper No. 1,107
By Philip Bunn, Lena Anayi, Emily Barnes, Nicholas Bloom, Paul Mizen, Gregory Thwaites and Ivan Yotzov
Macro data suggest a convex relationship between inflation and economic slack, but identifying causality is challenging. Using micro data from large panel surveys of UK and US firms, we show that the response of prices to demand shocks is also convex at the firm level. We obtain similar results using three different empirical exercises examining: the impact of Covid demand shocks, the response to sales shocks, and hypothetical shocks from a survey experiment. This convexity is strongest in firms and industries with higher inflation, disappears at horizons beyond two years, and is also present in response to cost shocks. We rationalise these findings in a menu cost model with positive trend inflation and decreasing returns at the firm level, which replicates firm and aggregate Phillips curve convexity. The non‑linearity emerges from trend inflation pushing firms closer to their price increase thresholds.
This version was updated in October 2025.
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