The Silent Distortion of Relative Prices

Vipin P Veetil

Papers from arXiv.org

Abstract: This paper presents a production network model of inflationary dynamics in which inflation can have near-zero correlation with the size of price change yet generate significant distortions in relative prices. New money enters unevenly across firms and percolates through buyer-seller links, thereby displacing relative prices even when every price is free to adjust and every market clears. The magnitude of price distortion depends critically on the spectral gap of the production network, which sets the rate at which the economy converges to equilibrium. We quantify the mechanism on a reconstructed production network with the universe of firms in the United States. At 1% inflation, the typical firm's relative-price distortion is of the same magnitude as the inflation rate. The size of price change remains essentially uncorrelated with the magnitude of relative price distortion.

Date: 2026-01, Revised 2026-09
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