Is Sticky Price Adjustment Important for Output Fluctuations?

John Keating and Isaac Kanyama

No 201301, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: We find that shocks with no immediate effect on the price level explain essentially all short-run variance of aggregate output while shocks that immediately affect price explain virtually none of that variance. Similar findings are obtained with aggregate, sectoral and industry-level data, both seasonally adjusted and not seasonally adjusted. With aggregate data, shocks that immediately raise the price level eventually cause output to fall while shocks that affect price with a lag immediately raise output and eventually cause the price level to rise. These responses combined with the variance decompositions suggest the short-run aggregate supply curve is nearly horizontal and the aggregate demand curve is nearly vertical. A statistical model that identifies shocks that don't affect prices for at least two months is also developed. Shocks with the slowest effect on prices explain essentially all of the short-run output variance in almost all cases. This robust finding is inconsistent with theories in which prices adjust rapidly to clear markets.

Keywords: sticky price adjustment; aggregate supply and demand; moving average representation; identification restrictions. (search for similar items in EconPapers)
Pages: 34 pages
Date: 2013-01
New Economics Papers: this item is included in nep-bec
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Journal Article: Is sticky price adjustment important for output fluctuations? (2015)
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