Price Setting During a Currency Changeover

We use the euro cash changeover, a large-scale and purely nominal reform that requires all firms to redenominate posted prices, to distinguish among theories of price rigidity. We develop a nonstationary menu-cost model in which firms anticipate the changeover date and may combine currency adoption with real price adjustment. The announcement makes the firm’s inaction region time-varying, a singular control problem with a moving boundary for which closed-form characterizations are rarely available. We solve this problem analytically by perturbation, recovering the whole path of the boundary, the date at which firms begin adopting the new currency, and the implied pricing moments. The model predicts that, as the changeover approaches, firms adjust more frequently but by smaller amounts, compressing the distribution of price changes. We test these predictions using historical CPI micro data from Austria, Finland, Greece, and Slovakia, a UK benchmark, and daily price data from the recent changeovers in Croatia and Bulgaria. Across changeovers, adjustment frequency rises while the size and dispersion of price changes fall. The model adds a single parameter to the standard menu-cost setup, the cost of pricing in the wrong currency. Calibrating it to the observed rise in adjustment frequency, the model reproduces the decline in the size of price changes and its subsequent recovery, neither of which is targeted. The evidence supports state-dependent price-setting models over models in which nominal redenomination leaves real pricing behavior unchanged.