An equilibrium analysis of relative price changes and aggregate inflation

Abstract

The existence of a relationship between the degree of skewness of the cross-section distribution of price changes and aggregate inflation has been known.for some time. The conventional interpretation of .this relationship is that it reflects sluggishness in the adjustment of individual prices in response to shocks. In this paper we question the traditiornl interpretation of this observation, and show that a simple equilibrium model with complete price flexibility is capable of reproducing the relationship observed in the data.

Inside money, credit, and investment

“…For example, if velocity were chosen after the monetary injection was observed, then total deposits spent within the period could effectively respond after the shock allowing the environment to reduce to one where nominal shocks are completely neutral. Nonetheless, the fixed velocity component of these constraints could also be interpreted as solvency conditions set forth by the commercial bank as in Balke and Wynne (2000).…”

“…Fuerst, 1 See the appendix for a description of the VAR estimation exercise, and the description and construction of the data set. 2 It is found that correlations between household investment and M1 over postwar data were stronger than correlations between household investment and the monetary base (available on request), implying the largest correlations exist between household investment and inside money holdings. 3 Gertler and Gilchrist (1995) take this idea a step further by supporting the notion that credit market imperfections play a role in monetary transmission.…”

“…First, household investment is contemporaneously correlated with M1 while business investment lags M1. 2 Second, the change in household credit outstanding is positively correlated with household investment and its response to a monetary tightening is noticeably larger. These observations are illustrated in Figures 2 and 3 by reporting the VAR responses to the same Federal Funds rate innovation.…”

Interpreting the Correlation Between Inflation and the Skewness of Relative Prices: A Comment on Bryan and Cecchetti

“…The substance of their argument, we believe, is that it is easy to explain the correlation between inflation and skewness. Previous authors have worked hard to explain this fact: Ball and Mankiw (1995) propose that this correlation can be explained with ''menu cost'' models of price adjustment, while Balke and Wynne (1996) argue that it can be explained by a multisector, real-business-cycle model. By contrast, Bryan and Cecchetti generate the inflation-skewness correlation in a much simpler model.…”

Relative importance of sectoral and aggregate sources of price changes

“…More recently, Ball and Mankiw (1995) argue that the existence of menu costs faced by firms in adjusting prices gives rise to relative price changes, which in turn leads to aggregate inflation. Using a multisector flexible price general equilibrium model, Balke and Wynne (2000), on the other hand, argue that sectoral technology shocks can 1 One notable exception is Barsky and Kilian (2002) who argue that Fed's expansionary monetary policy bears much of the blame for the stagflation of the 70s.…”