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Relative Price Shocks and Inflation

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Abstract

Inflation is determined by interaction between real factors and monetary policy. Among the most important real factors are shocks to the supply and demand for different components of the consumption basket. We use an estimated multi-sector New Keynesian model to decompose the behavior of U.S. inflation into contributions from sectoral (or "relative price") shocks, monetary policy shocks, and aggregate real shocks. The model is estimated by maximum likelihood with U.S. data for the post-1994 period in which inflation and the monetary policy regime appeared to be stable. In addition to providing a broad decomposition of inflation behavior, we enlist the model to help us understand the inflation shortfall from 2012 to 2019, and the dramatic inflation movements during the COVID pandemic.

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  • Francisco J. Ruge-Murcia & Alexander L. Wolman, 2022. "Relative Price Shocks and Inflation," Working Paper 22-07, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:94408
    DOI: 10.21144/wp22-07
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    Cited by:

    1. Ferrante, Francesco & Graves, Sebastian & Iacoviello, Matteo, 2023. "The inflationary effects of sectoral reallocation," Journal of Monetary Economics, Elsevier, vol. 140(S), pages 64-81.

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    More about this item

    Keywords

    Monetary Policy; sectoral shocks; inflation shortfall; COVID-19;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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