Can Supply Shocks Be Inflationary with a Flat Phillips Curve?

Jean-Paul L'Huillier and Gregory Phelan

No 23-36, Working Papers from Federal Reserve Bank of Cleveland

Abstract: Not in standard models. With conventional pricing frictions, imposing a flat Phillips curve also imposes a price level that is rigid with respect to supply shocks. In the New Keynesian model, price markup shocks need to be several orders of magnitude bigger than other shocks in order to fit the data, leading to unreasonable assessments of the magnitude of the increase in costs during inflationary episodes. To account for the facts, we propose a strategic microfoundation of shock-dependent price stickiness: prices are sticky with respect to demand shocks but flexible with respect to supply shocks. This friction is demand-intrinsic, in line with narrative accounts for the imperfect adjustment of prices. Firms can credibly justify a price increase due to a rise in costs, whereas it is harder to do so when demand increases. Inflation from supply shocks is efficient and does not justify a monetary policy response.

Keywords: cost-push shocks; shock dependence; price stickiness; output-inflation trade-off (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Pages: 68
Date: 2023-12-28
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Working Paper: Can Supply Shocks be Inflationary with a Flat Phillips Curve? (2023)
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DOI: 10.26509/frbc-wp-202336

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