Price Stickiness and Inflation
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.
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- Laurence Ball & N. Gregory Mankiw, 1992.
"Asymmetric Price Adjustment and Economic Fluctuations,"
NBER Working Papers
4089, National Bureau of Economic Research, Inc.
- Ball, Laurence & Mankiw, N Gregory, 1994. "Asymmetric Price Adjustment and Economic Fluctuations," Economic Journal, Royal Economic Society, vol. 104(423), pages 247-61, March.
- 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.
- Ball, Laurence & Mankiw, N Gregory, 1995.
"Relative-Price Changes as Aggregate Supply Shocks,"
The Quarterly Journal of Economics,
MIT Press, vol. 110(1), pages 161-93, February.
- Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
- Ball, L. & Mankiw, G.H., 1992. "Relative-Price Change as Aggregate Supply Shocks," Harvard Institute of Economic Research Working Papers 1609, Harvard - Institute of Economic Research.
- Laurence Ball & N. Gregory Mankiw, 1992. "Relative-Price Changes as Aggregate Supply Shocks," NBER Working Papers 4168, National Bureau of Economic Research, Inc.
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- 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.
- Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
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- 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 728-41, September.
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