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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page The Lead of Output over Inflation in Sticky Price Models
Michael T. Kiley

Abstract: Output growth is negatively correlated with inflation, and detrended output is positively correlated with inflation, in the major North American and European economies. In addition, output growth and detrended output lead inflation. I explore the consistency of these correlations with three models of price adjustment: the partial adjustment model, a staggered price setting model, and the P-bar model. The ratio of the variance of supply to demand shocks necessary to match the pattern of output- inflation correlations can be ranked across the three models; the P-Bar model requires the lowest ratio, and the partial adjustment model requires the highest ratio. These results reveal that the recent burst of researchers using the partial adjustment model will find a larger role for supply shocks than alternative models of price rigidity.

Keywords: Output, inflation, sticky prices

Full paper (158 KB PDF) | Full paper (328 KB Postscript)

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Last update: July 16, 1997