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Relative-price changes as aggregate supply shocks

  • Laurence Ball
  • N. Gregory Mankiw

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. The authors show that this theoretical result explains a large fraction of movements in postwar U.S. inflation. Moreover, their model suggests measures of supply shocks that perform better than traditional measures, such as the relative prices of food and energy. Copyright 1995, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 93-13.

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Date of creation: 1993
Date of revision:
Handle: RePEc:fip:fedpwp:93-13
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  1. Batchelor, R. A., 1981. "Aggregate expectations under the stable laws," Journal of Econometrics, Elsevier, vol. 16(2), pages 199-210, June.
  2. Ball, L. & Mankiw, N.G., 1992. "Asymmetric Price Adjustment and Economic Fluctuations," Harvard Institute of Economic Research Working Papers 1602, Harvard - Institute of Economic Research.
  3. Gordon, Robert J, 1990. "What Is New-Keynesian Economics?," Journal of Economic Literature, American Economic Association, vol. 28(3), pages 1115-71, September.
  4. Andrew C. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," NBER Working Papers 2311, National Bureau of Economic Research, Inc.
  5. Mizon, Grayham E & Safford, J Claire & Thomas, Stephen H, 1990. "The Distribution of Consumer Price Changes in the United Kingdom," Economica, London School of Economics and Political Science, vol. 57(226), pages 249-62, May.
  6. Blinder, Alan S, 1991. "Why Are Prices Sticky? Preliminary Results from an Interview Study," American Economic Review, American Economic Association, vol. 81(2), pages 89-96, May.
  7. Akerlof, George A & Yellen, Janet L, 1985. "A Near-rational Model of the Business Cycle, with Wage and Price Intertia," The Quarterly Journal of Economics, MIT Press, vol. 100(5), pages 823-38, Supp..
  8. Vining, Daniel R, Jr & Elwertowski, Thomas C, 1976. "The Relationship between Relative Prices and the General Price Level," American Economic Review, American Economic Association, vol. 66(4), pages 699-708, September.
  9. Laurence Ball & N. Gregory Mankiw & David Romer, 1988. "The New Keynsesian Economics and the Output-Inflation Trade-off," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 1-82.
  10. Caplin, Andrew & Leahy, John, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 683-708, August.
  11. Parkin, Michael, 1986. "The Output-Inflation Trade-off When Prices Are Costly to Change," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 200-224, February.
  12. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 381-442.
  13. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May.
  14. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  15. Blejer, Mario I, 1983. "On the Anatomy of Inflation: The Variability of Relative Commodity Prices in Argentina," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(4), pages 469-82, November.
  16. Arthur M. Okun, 1975. "Inflation: Its Mechanics and Welfare Costs," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(2), pages 351-402.
  17. Robert J. Gordon, 1975. "Alternative Responses of Policy to External Supply Shocks," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1), pages 183-206.
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