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Is Sticky Price Adjustment Important for Output Fluctuations?

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  • John W. Keating

    (Department of Economics, The University of Kansas)

  • Isaac K. Kanyama

    (Department of Economics, University of Johannesburg)

Abstract

We find that shocks with no immediate effect on the price level explain essentially all short-run variance of aggregate output while shocks that immediately affect price explain virtually none of that variance. Similar findings are obtained with aggregate, sectoral and industry-level data, both seasonally adjusted and not seasonally adjusted. With aggregate data, shocks that immediately raise the price level eventually cause output to fall while shocks that affect price with a lag immediately raise output and eventually cause the price level to rise. These responses combined with the variance decompositions suggest the short-run aggregate supply curve is nearly horizontal and the aggregate demand curve is nearly vertical. A statistical model that identifies shocks that don't affect prices for at least two months is also developed. Shocks with the slowest effect on prices explain essentially all of the short-run output variance in almost all cases. This robust finding is inconsistent with theories in which prices adjust rapidly to clear markets.

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Bibliographic Info

Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201301.

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Length: 34 pages
Date of creation: Jan 2013
Date of revision:
Handle: RePEc:kan:wpaper:201301

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Keywords: sticky price adjustment; aggregate supply and demand; moving average representation; identification restrictions.;

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References

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