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Can Supply Shocks be Inflationary with a Flat Phillips Curve?

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  • Jean-Paul L’Huillier
  • Gregory Phelan

Abstract

Empirical estimates find that the relationship between inflation and the output gap is close to nonexistent—a so-called flat Phillips curve. We show that standard pricing frictions cannot simultaneously produce a flat Phillips curve and meaningful inflation from plausible supply shocks. This is because imposing a flat Phillips curve immediately implies that the price level is also rigid with respect to supply shocks. In quantitative versions of the New Keynesian model, price markup shocks need to be several orders of magnitude bigger than other shocks in order to fit the data, leading to unreasonable assessments of the magnitude of the increase in costs during inflationary episodes. Hence, we propose a strategic microfoundation of price stickiness in which prices are sticky with respect to demand shocks but flexible with respect to supply shocks (Working Paper no. 23-03).

Suggested Citation

  • Jean-Paul L’Huillier & Gregory Phelan, 2023. "Can Supply Shocks be Inflationary with a Flat Phillips Curve?," Working Papers 23-03, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:23-03
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    References listed on IDEAS

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    Cited by:

    1. Mishel Ghassibe & Anton Nakov, 2025. "Business Cycles with Pricing Cascades," Working Papers 1525, Barcelona School of Economics.
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    3. Bušs, Ginters & Traficante, Guido, 2025. "The Return of Inflation: Look-Through Policy Under Incomplete Information," Dynare Working Papers 85, CEPREMAP.
    4. Harding, Martín & Lindé, Jesper & Trabandt, Mathias, 2023. "Understanding post-COVID inflation dynamics," Journal of Monetary Economics, Elsevier, vol. 140(S), pages 101-118.

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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