Relative-Price Changes as Aggregate Supply Shocks

Abstract

This paper proposes a theory of supply shocks, or shifts in the short-run Phillips curve, based on relative-price changes and frictions in nominal price adjustment. When price adjustment is costly, firms adjust to large shocks but not to small shocks, and so large shocks have disproportionate effects on the price level. Therefore, aggregate inflation depends on the distribution of relative-price changes: inflation rises when the distribution is skewed to the right, and falls when the distribution is skewed to the left. We show that this theoretical result explains a large fraction of movements in postwar U.S. inflation. Moreover, our model suggests measures of supply shocks that perform better than uaditional measures, such as the relative prices of food and energy.

Portfolio and financing adjustments for U.S. banks: Some empirical evidence

“…This is because it is more difficult for firms to formulate their production-investment plans when the selling price for their product and the cost price for their inputs are changing at different rates. Evidence supporting the procyclical variability of relative prices is presented in Anderson (1994), Anderson (2002), Balke and Wynne (2000), Ball and Mankiw (1995), and Parsley (1996) among many others. Empirical evidence on the cyclical pattern of risk is provided by Brandt and Kang (2003).…”

Are fiscal deficits inflationary?

“…First, Ball and Mankiw (1995) propose a theoretical model to describe supply-side shocks, wherein an increase in the relative price of oil could affect the aggregate price level. Thus, the change in the price of oil is considered as a control variable in several empirical studies; see also Loungani and Swagel (2003), Catão and Terrones (2005).…”

Good deflation/bad deflation and Japanese economic recovery

“…If supply shocks are more likely to change the price of goods relative to one another, and demand shocks are more likely to change the price of all goods relative to money, but not to each other, defining a core-price change statistic is useful for better appreciating the imperatives imposed on a central bank (Ball and Mankiw 1995). Statistical agencies in many countries produce such a statistic by taking the CPI and excluding from it foodstuffs, energy and/or other volatile components.…”

“…In a world of highly flexible prices, if prices of some items go down, purchasers then have more to spend on other items forcing those prices up. It is not clear whether the average should be influenced at all (Ball and Mankiw 1995). …”

“…The price-change distribution can be skewed and leptokurtopic and its mean can vary with its standard deviation, and yet the consequences of any supply shock might be short-lived (Ball andMankiw 1995 andParsley 1996). The price changes observed for Japan and the particular shape of its price-change distribution may reflect nothing more than short-term frictions and misperceptions in the economy.…”