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Imperfect Information, Composition of Demand Shocks, and the Flattening of the Phillips Curve

Author

Listed:
  • Tatsushi Okuda
  • Tomohiro Tsuruga
  • Francesco Zanetti

Abstract

We study why inflation responds differently to economic activity over time. Using survey data covering the universe of Japanese firms, we show that firms are unable to perfectly distinguish aggregate from sector-specific demand changes, leading to positively correlated expectations about these two components. We develop a model with imperfect information that reproduces this pattern and predicts that higher relative volatility of sector-specific demand reduces the sensitivity of inflation to changes in aggregate demand, thus flattening the Phillips curve. Testing this prediction with Japanese data from 1976 to 2022, we find that increases in the volatility of sectoral demand shocks explain significant changes in the Phillips curve slope over the sample period. Our results provide a novel explanation for the flattening of the Phillips curve: the composition of shocks -- not just their magnitude -- critically affects the sensitivity of inflation to aggregate demand.

Suggested Citation

  • Tatsushi Okuda & Tomohiro Tsuruga & Francesco Zanetti, 2026. "Imperfect Information, Composition of Demand Shocks, and the Flattening of the Phillips Curve," CESifo Working Paper Series 12607, CESifo.
    • Handle: RePEc:ces:ceswps:_12607
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    References listed on IDEAS

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    1. Hassan Afrouzi, 2024. "Strategic Inattention, Inflation Dynamics, and the Nonneutrality of Money," Journal of Political Economy, University of Chicago Press, vol. 132(10), pages 3378-3420.
    2. Hassan Afrouzi & Choongryul Yang, 2021. "Dynamic Rational Inattention and the Phillips Curve," CESifo Working Paper Series 8840, CESifo.
    3. Sushant Acharya, 2017. "Costly Information, Planning Complementarities, and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(4), pages 823-850, June.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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