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Inflation Distorts Relative Prices: Theory and Evidence

Author

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  • Klaus Adam
  • Andrey Alexandrov
  • Henning Weber

Abstract

Using a novel identification approach derived from sticky price theories with time or state-dependent adjustment frictions, we empirically identify the effect of inflation on relative price distor- tions. Our approach can be directly applied to micro price data, does not rely on estimating the gap between actual and flexible prices, and only assumes stationarity of unobserved shocks. Us- ing U.K. CPI micro price data, we document that suboptimally high (or low) inflation is associated with distortions in relative prices that are highly statistically signficant. At the aggregate level, fluctuations in inefficient price dispersion are sizable and covary positively with aggregate inflation. In contrast, overall price dispersion fails to covary with innflation because it is mainly driven by trends in the dispersion of flexible prices.

Suggested Citation

  • Klaus Adam & Andrey Alexandrov & Henning Weber, 2023. "Inflation Distorts Relative Prices: Theory and Evidence," CRC TR 224 Discussion Paper Series crctr224_2023_406, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2023_406
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp406
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    Cited by:

    1. Guido Ascari & Paolo Bonomolo & Qazi Haque, 2023. "The Long-Run Phillips Curve is ... a Curve," Working Papers 789, DNB.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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