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The cyclical behavior of prices: interpreting the evidence

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  • John P. Judd
  • Bharat Trehan

Abstract

Whether prices are pro- or counter-cyclical represents a major difference in the predictions of models that focus on aggregate demand shocks as the primary source of business cycle fluctuations, versus those that emphasize shocks to aggregate supply. Earlier studies have interpreted their finding of generally negative cross-correlations between output and prices in the post-WWII U.S. as being more consistent with supply-driven models. In the present paper, we ask whether this interpretation is appropriate. We show that the signs of price-output correlations have little to say about which type shock generated them, or whether prices are best characterized as pro- or counter-cyclical. In fact, negative price output correlations can be generated from a variety of models, including demand-driven models that have pro-cyclical prices. (Revision of Working Paper 93-09)

Suggested Citation

  • John P. Judd & Bharat Trehan, 1993. "The cyclical behavior of prices: interpreting the evidence," Working Papers in Applied Economic Theory 93-14, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfap:93-14
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    Cited by:

    1. Michael Kiley, 2002. "The lead of output over inflation in sticky price models," Economics Bulletin, AccessEcon, vol. 5(5), pages 1-7.
    2. Lengnick, Matthias, 2013. "Agent-based macroeconomics: A baseline model," Journal of Economic Behavior & Organization, Elsevier, vol. 86(C), pages 102-120.
    3. Canova, Fabio & de Nicolo, Gianni, 2003. "On the sources of business cycles in the G-7," Journal of International Economics, Elsevier, vol. 59(1), pages 77-100, January.
    4. Joseph Haslag & William Brock, 2014. "On Understanding the Cyclical Behavior of the Price Level and Inflation," Working Papers 1404, Department of Economics, University of Missouri, revised 01 Jul 2014.
    5. Rotemberg, Julio J., 1996. "Prices, output, and hours: An empirical analysis based on a sticky price model," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 505-533, June.
    6. Pakko, Michael R, 2000. "The Cyclical Relationship between Output and Prices: An Analysis in the Frequency Domain," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 382-399, August.
    7. James A. Kahn & Margaret M. McConnell & Gabriel Perez-Quiros, 2002. "On the causes of the increased stability of the U.S. economy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 183-202.
    8. James Peery Cover & C. James Hueng, 2006. "Why Did the Sign of the Price-Output Correlation Change? Evidence from a Structural VAR with GARCH Errors," Working Papers 200602, Ball State University, Department of Economics, revised Mar 2006.
    9. Brian Motley, 1998. "Growth and inflation: a cross-country study," Economic Review, Federal Reserve Bank of San Francisco, pages 15-28.
    10. Dean Croushore, 1998. "Low inflation: the surprise of the 1990s," Business Review, Federal Reserve Bank of Philadelphia, issue Jul, pages 3-12.
    11. David Smant, 1996. "Re-examining the cyclical behaviour of prices and output," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 132(4), pages 651-674, December.
    12. Cover James Peery & Pecorino Paul, 2003. "Optimal Monetary Policy and the Correlation between Prices and Output," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-21, February.
    13. den Haan, Wouter J. & Sumner, Steven W., 2004. "The comovement between real activity and prices in the G7," European Economic Review, Elsevier, vol. 48(6), pages 1333-1347, December.
    14. Brock, William A. & Haslag, Joseph H., 2016. "A tale of two correlations: Evidence and theory regarding the phase shift between the price level and output," Journal of Economic Dynamics and Control, Elsevier, vol. 67(C), pages 40-57.
    15. Hartley, Peter R. & Whitt Jr, Joseph A., 2003. "Macroeconomic fluctuations: Demand or supply, permanent or temporary?," European Economic Review, Elsevier, vol. 47(1), pages 61-94, February.
    16. Agenor, Pierre-Richard & McDermott, C John & Prasad, Eswar S, 2000. "Macroeconomic Fluctuations in Developing Countries: Some Stylized Facts," World Bank Economic Review, World Bank Group, vol. 14(2), pages 251-285, May.
    17. Francesco Busato, 2004. "Relative Demand Shocks," Economics Working Papers 2004-11, Department of Economics and Business Economics, Aarhus University.
    18. Wouter J. den Haan, 2002. "The Comovement between Real Activity and Prices in the G7," Tinbergen Institute Discussion Papers 02-092/2, Tinbergen Institute.
    19. Paul Cashin & Sam Ouliaris, 2004. "Key Features of Australian Business Cycles," Australian Economic Papers, Wiley Blackwell, vol. 43(1), pages 39-58, March.
    20. Smant, David J. C., 1998. "Modelling trends, expectations and the cyclical behaviour of prices," Economic Modelling, Elsevier, vol. 15(1), pages 151-161, January.
    21. P J Pérez, 2001. "Cyclical Properties in the Main Western Economies," Centre for Growth and Business Cycle Research Discussion Paper Series 33, Economics, The Univeristy of Manchester.
    22. repec:ebl:ecbull:v:5:y:2002:i:5:p:1-7 is not listed on IDEAS
    23. Yang-Woo Kim, 1996. "Are prices countercyclical? Evidence from East Asian countries," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 69-82.
    24. den Haan, Wouter J., 2000. "The comovement between output and prices," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 3-30, August.

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    Keywords

    Prices ; Business cycles ; Econometric models;

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