Working Paper: NBER ID: w4168
Authors: Laurence Ball; Gregory Mankiw
Abstract: This paper proposes a theory of supply shocks, or shifts in the short-run Phillips curve, based on relative-price changes and frictions in nominal price adjustment. When price adjustment is costly, firms adjust to large shocks but not to small shocks, and so large shocks have disproportionate effects on the price level. Therefore, aggregate inflation depends on the distribution of relative-price changes: inflation rises when the distribution is skewed to the right, and falls when the distribution is skewed to the left. We show that this theoretical result explains a large fraction of movements in postwar U.S. inflation. Moreover, our model suggests measures of supply shocks that perform better than traditional measures, such as the relative prices of food and energy.
Keywords: Inflation; Supply Shocks; Relative Prices; Menu Costs
JEL Codes: E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large relative price shocks (E30) | inflation (E31) |
| skewness of relative price changes (D39) | inflation (E31) |
| skewness of relative price changes (right) (D39) | inflation (E31) |
| skewness of relative price changes (left) (D39) | inflation (E31) |
| innovations in aggregate inflation (E31) | skewness of relative price changes (D39) |