Demand Shocks, Inflation and the Business Cycle
This paper examines how firms adjust output and prices in response to changes in demand and costs, paying particular attention to the role that capacity utilisation plays in affecting these relationships. It primarily uses qualitative survey data on manufacturing firms’ actual and expected outcomes for these variables, and traces through the short-term effects of changes in demand on costs, output and prices. The survey data also enables an analysis of how firms respond to unexpected shocks to costs and demand. The paper finds that strong demand growth leads to increases in both output and prices, and there is some evidence that capacity constraints do affect this relationship. When capacity utilisation is high, changes in demand have a smaller effect on output and a larger effect on prices, than when capacity utilisation is low. The paper distinguishes between the direct effect that changes in demand have on prices, through changes in margins, and the indirect effect, through demand-induced changes in firms’ costs. It finds that inflationary pressures are predominantly driven by increases in input costs. While margins appear to move pro-cyclically, there is a degree of asymmetry in their behaviour. Movements in margins appear to be largest in recessionary periods with margins falling as the economy goes into recession and then being rebuilt relatively early in the recovery. In boom times pressures on prices come largely through increases in costs, with little additional contribution from changes in margins.
|Date of creation:||Dec 1994|
|Date of revision:|
|Contact details of provider:|| Postal: GPO Box 3947, Sydney NSW 2001|
Web page: http://www.rba.gov.au/
More information through EDIRC
|Order Information:||Web: http://www.rba.gov.au/forms/rdp-order-form/|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Paul W. Bauer, 1990. "A reexamination of the relationship between capacity utilization and inflation," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 2-12.
- Eytan Sheshinski & Yoram Weiss, 1983. "Optimum Pricing Policy under Stochastic Inflation," Review of Economic Studies, Oxford University Press, vol. 50(3), pages 513-529.
- Heckman, James J, 1978.
"Dummy Endogenous Variables in a Simultaneous Equation System,"
Econometric Society, vol. 46(4), pages 931-59, July.
- James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
- Benabou, Roland, 1992.
"Inflation and markups : Theories and evidence from the retail trade sector,"
European Economic Review,
Elsevier, vol. 36(2-3), pages 566-574, April.
- Benabou, R., 1991. "Inflation and Markups: Theories and Evidence from the Retail Trade Sector," Working papers 587, Massachusetts Institute of Technology (MIT), Department of Economics.
- Hausman, Jerry A & Wise, David A, 1978.
"A Conditional Probit Model for Qualitative Choice: Discrete Decisions Recognizing Interdependence and Heterogeneous Preferences,"
Econometric Society, vol. 46(2), pages 403-26, March.
- J. A. Hausman & D. A. Wise, 1976. "A Conditional Profit Model for Qualitative Choice: Discrete Decisions Recognizing Interdependence and Heterogeneous Preferences," Working papers 173, Massachusetts Institute of Technology (MIT), Department of Economics.
- Chadha, Bankim & Prasad, Eswar, 1994.
"Are prices countercyclical? Evidence from the G-7,"
Journal of Monetary Economics,
Elsevier, vol. 34(2), pages 239-257, October.
- Matthew D. Shapiro, 1989. "Assessing the Federal Reserve's Measures of Capacity and Utilization," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 181-242.
- Bruce C. Greenwald & Joseph E. Stiglitz, 1988.
"Financial Market Imperfections and Business Cycles,"
NBER Working Papers
2494, National Bureau of Economic Research, Inc.
- Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 108(1), pages 77-114.
- Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 683-708.
- Catherine J. Morrison, 1988.
"Markups in U.S. and Japanese Manufacturing: A Short Run Econometric Analysis,"
NBER Working Papers
2799, National Bureau of Economic Research, Inc.
- Morrison, Catherine J, 1992. "Markups in U.S. and Japanese Manufacturing: A Short-Run Econometric Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(1), pages 51-63, January.
- Bils, Mark, 1987. "The Cyclical Behavior of Marginal Cost and Price," American Economic Review, American Economic Association, vol. 77(5), pages 838-55, December.
- Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
- Flaig, Gebhard & Steiner, Viktor, 1989. "Stability and Dynamic Properties of Labour Demand in West German Manufacturing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 51(4), pages 395-412, November.
- Darren Flood & Philip Lowe, 1993. "Inventories and the Business Cycle," RBA Research Discussion Papers rdp9306, Reserve Bank of Australia.
- Robert J. Barro, 1972. "A Theory of Monopolistic Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 39(1), pages 17-26.
- Carlson, John A & Parkin, J Michael, 1975. "Inflation Expectations," Economica, London School of Economics and Political Science, vol. 42(166), pages 123-38, May.
- Buckle, Robert A & Meads, Chris S, 1991. "How Do Firms React to Surprising Changes to Demand? A Vector Autoregressive Analysis Using Business Survey Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 53(4), pages 451-66, November.
- Pesaran, M Hashem, 1985. "Formation of Inflation Expectations in British Manufacturing Industries," Economic Journal, Royal Economic Society, vol. 95(380), pages 948-75, December.
When requesting a correction, please mention this item's handle: RePEc:rba:rbardp:rdp9411. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Paula Drew)
If references are entirely missing, you can add them using this form.