Cyclical Co-movement between Output, the Price Level, and Inflation
Over time, there has been a dramatic change in our understanding of the relationship between the price level and output over the business cycle. For several decades, the conventional wisdom maintained that the price level are procyclical. Arguably, the biggest development in our understanding came about because Lucas (1977) offered a transformative elegant definition of the business cycle itself. Armed with the definition that business cycles are deviations in output from trend, researchers applied new econometric techniques to re-consider key business-cycle facts. In this paper, we concentrate on two related sets of business-cycle facts. More specifically, we consider the contemporaneous correlation between the price level and output and between the inflation rate and output. Of course, the relationship between the price level and inflation is tautological; the inflation rate is the time derivative of the log of the price level. The existing evidence indicates a very interesting pair of observations; namely, that the price level is countercyclical and the inflation rate procyclical.
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- Ashley, R & Granger, C W J & Schmalensee, R, 1980. "Advertising and Aggregate Consumption: An Analysis of Causality," Econometrica, Econometric Society, vol. 48(5), pages 1149-1167, July.
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- Mankiw, N Gregory, 1989. "Real Business Cycles: A New Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 79-90, Summer.
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