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Price Stickiness and Inflation

Author

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  • Richard De Abreu Lourenco

    (Reserve Bank of Australia)

  • David Gruen

    (Reserve Bank of Australia)

Abstract

A recent model of firms’ pricing behaviour by Laurence Ball and Gregory Mankiw has novel implications for the effect of relative price shocks on inflation. This paper examines these implications and establishes the importance of expected inflation for this story. We derive the model relationship between expected inflation, the economy-wide distribution of industry price changes and actual inflation, and show that both Australian and US industry-price data strongly support this derived relationship. The inflationary impact of relative price shocks depends strongly on expected inflation. When expected inflation is high, a rise in the economy-wide dispersion of shocks is inflationary in the short-run. By contrast, when expected inflation is low, a rise in the dispersion of shocks has minimal impact on inflation. Economy-wide relative price shocks, like terms of trade shocks, are an unavoidable feature of the economic landscape. Their disruptive effect on inflation is minimal, however, when average inflation, and therefore average expected inflation, is kept low.

Suggested Citation

  • Richard De Abreu Lourenco & David Gruen, 1995. "Price Stickiness and Inflation," RBA Research Discussion Papers rdp9502, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp9502
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    File URL: http://www.rba.gov.au/publications/rdp/1995/pdf/rdp9502.pdf
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    1. Ball, Laurence & Mankiw, N Gregory, 1994. "Asymmetric Price Adjustment and Economic Fluctuations," Economic Journal, Royal Economic Society, vol. 104(423), pages 247-261, March.
    2. Hausman, Jerry, 2015. "Specification tests in econometrics," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 38(2), pages 112-134.
    3. Cecchetti, Stephen G., 1986. "The frequency of price adjustment : A study of the newsstand prices of magazines," Journal of Econometrics, Elsevier, vol. 31(3), pages 255-274, April.
    4. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
    5. Laurence Ball & N. Gregory Mankiw, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 161-193.
    6. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-741, September.
    7. 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.
    8. Eytan Sheshinski & Yoram Weiss, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 44(2), pages 287-303.
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    Cited by:

    1. Döpke, Jörg & Pierdzioch, Christian, 2001. "Inflation and the Skewness of the Distribution of Relative Price Changes: Empirical Evidence for Germany," Kiel Working Papers 1059, Kiel Institute for the World Economy (IfW).
    2. Richard Ashley & Haichun Ye, 2012. "On the Granger causality between median inflation and price dispersion," Applied Economics, Taylor & Francis Journals, vol. 44(32), pages 4221-4238, November.
    3. A. Nazif Çatik & Christopher Martin & A. Özlem Onder, 2011. "Relative price variability and the Phillips Curve: evidence from Turkey," Journal of Economic Studies, Emerald Group Publishing, vol. 38(5), pages 546-561, September.
    4. María Ángeles Caraballo & Carlos Usabiaga, 2003. "Análisis de la estructura de la inflación de las regiones españolas: La metodología de Ball y Mankiw," Economic Working Papers at Centro de Estudios Andaluces E2003/44, Centro de Estudios Andaluces.
    5. Michael F. Bryan & Stephen G. Cecchetti, 1999. "Inflation And The Distribution Of Price Changes," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 188-196, May.
    6. Constantina Kottaridi & Diego Méndez-Carbajo & Dimitrios D. Thomakos, 2007. "Inflation Dynamics and the Cross-Sectional Distribution of Prices in the E.U. Periphery," Working Paper series 43_07, Rimini Centre for Economic Analysis.
    7. M. Angeles Caraballo & Carlos Usabiaga, 2009. "The relevance of supply shocks for inflation: the spanish case," Applied Economics, Taylor & Francis Journals, vol. 41(6), pages 753-764.
    8. Mª Ángeles Caraballo Pou & Carlos Dabús, 2005. "Nominal rigidities, relative prices and skewness," Economic Working Papers at Centro de Estudios Andaluces E2005/17, Centro de Estudios Andaluces.
    9. Sartaj Rasool Rather, 2016. "Asymmetric Impact of Relative Price Shocks in Presence of Trend Inflation," Working Papers 2016-153, Madras School of Economics,Chennai,India.
    10. Luc Aucremanne & Guy Brys & Peter J Rousseeuw & Anja Struyf & Mia Hubert, 2003. "Inflation, relative prices and nominal rigidities," BIS Papers chapters,in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 81-105 Bank for International Settlements.
    11. Ball, Laurence & Mankiw, N. Gregory, 1999. "Interpreting the Correlation Between Inflation and the Skewness of Relative Prices: A Comment on Bryan and Cecchetti," Scholarly Articles 3415439, Harvard University Department of Economics.
    12. Maria A. Caraballo & Carlos Usabiaga, 2006. "Inflation and Supply Shocks in Spain: A Regional Approach," ERSA conference papers ersa06p335, European Regional Science Association.
    13. Carlos Usabiaga & María à ngeles Caraballo, 2004. "Inflation and Nominal Rigidities in Spanish Regions: The Ball and Mankiw Approach," ERSA conference papers ersa04p12, European Regional Science Association.
    14. Debelle, Guy & Lamont, Owen, 1997. "Relative Price Variability and Inflation: Evidence from U.S. Cities," Journal of Political Economy, University of Chicago Press, vol. 105(1), pages 132-152, February.
    15. Jonathan Kearns, 1998. "The Distribution and Measurement of Inflation," RBA Research Discussion Papers rdp9810, Reserve Bank of Australia.

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