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
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