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.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4168.
Length: Date of creation: Mar 1995 Date of revision: Publication status: published as Quarterly Journal of Economics, February 1995, p. 161-193 Handle: RePEc:nbr:nberwo:4168
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Find related papers by JEL classification: E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
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