Menu costs

Menu costs take their name from the literal cost a restaurant faces when it reprints its menu after changing prices. But in modern economics, the term covers all real and psychological costs that firms incur when changing prices: the management time required to decide on a new price, the cost of updating websites and systems, the risk of customer complaints or lost loyalty, and the cost of renegotiating contracts with suppliers and distributors.

These costs, even when individually small, are powerful enough to make firms reluctant to reprice frequently. As a result, prices are sticky — they adjust less often and in larger discrete jumps rather than continuously tracking costs. This stickiness is a central feature of core inflation: core prices move slowly even when underlying cost pressures shift, because firms batch their price changes.

Menu costs generate a key implication for inflation management: at very low inflation rates (near zero), the real costs of price adjustment relative to the adjustment benefit are higher, so firms adjust even less frequently. This can cause downward nominal rigidity — prices resist falling even when economic conditions call for lower prices, making deflation particularly damaging.

This is one reason why most central banks target slightly positive inflation (2%) rather than zero: a small positive rate "greases the wheels" of the economy by making it easier for relative prices to adjust without requiring nominal price cuts. The Fed's longer-run goals statement acknowledges this rationale. The ECB's strategy review cites similar reasoning for its 2% symmetric target.

Economists at central banks and statistics agencies measure price stickiness by analysing the microdata behind CPI — the individual price quotes collected each month. Studies find that the average US consumer price changes about once every 4–5 months; the average wage changes about once a year. Prices of fresh food and energy are highly flexible (change almost every month); prices of services like rent and medical care are very sticky (change only once or twice a year).

This variation in stickiness across categories explains why demand shocks are slow to pass through to the full CPI basket, and why core inflation (which excludes the most flexible prices) is a better real-time signal of underlying price pressure than headline CPI.