Is Inflation Driven by Aggregate or Sectoral Output Gaps?

James Morley and Jieying Zhang

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: We examine whether inflation is driven more by aggregate or sectoral output gaps. The aggregate output gap may not fully capture inflationary pressures because it can obscure sectoral shocks and heterogeneous propagation to prices. We find that aggregating sectoral output gaps by 'informational' weights estimated from real-time regressions produces a better fit of a Phillips curve relationship than using the aggregate output gap. We confirm the sectorally-aggregated output gap based on these weights has significant explanatory power for inflation beyond the aggregate output gap and find it performs better in forecasting inflation, although the aggregate output gap retains its own distinct information. An easy-to-compute 'inflation-informative-sectors' gap with fixed weights for the 11 most relevant, largely upstream, sectors closely approximates the gap using informational weights, with a 99% correlation, and provides an alternative explanation for the behaviour of inflation since the early 1990s than a flattening or nonlinear Phillips curve.

Keywords: sectoral shocks; inflation dynamics; Phillips curve; real-time analysis (search for similar items in EconPapers)
JEL-codes: C22 E31 E32 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2025-11, Revised 2026-04
New Economics Papers: this item is included in nep-for, nep-inv, nep-mac and nep-mon
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https://crawford.anu.edu.au/sites/default/files/20 ... evised_April2026.pdf Revised Version
https://crawford.anu.edu.au/sites/default/files/20 ... Original_Nov2025.pdf Original Version

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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2025-58

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