Inflation Distorts Relative Prices: Theory and Evidence

Klaus Adam, Andrey Alexandrov and Henning Weber

No 18088, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Using a novel identification approach derived from sticky price theories with time or state-dependent adjustment frictions, we empirically identify the effect of inflation on relative price distortions. Our approach can be directly applied to micro price data, does not rely on estimating the gap between actual and flexible prices, and only assumes stationarity of unobserved shocks. Using U.K. CPI micro price data, we document that suboptimally high (or low) inflation is associated with distortions in relative prices that are highly statistically significant. At the aggregate level, fluctuations in inefficient price dispersion are sizable and covary positively with aggregate inflation. In contrast, overall price dispersion fails to covary with inflation because it is mainly driven by trends in the dispersion of flexible prices.

Keywords: Inflation (search for similar items in EconPapers)
JEL-codes: E31 E58 (search for similar items in EconPapers)
Date: 2023-04
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Working Paper: Inflation Distorts Relative Prices: Theory and Evidence (2024)
Working Paper: Inflation distorts relative prices: Theory and evidence (2024)
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