Economics Working Paper 23105
Abstract: The US and other advanced countries suffered bursts of severe inflation in 2021and the first half of 2022, followed by declines of inflation later in 2022, in some countries. In times of high volatility of price determinants—cost and productivity—inflation can jump upward and fall downward at high speed, contrary to the uniformly sticky behavior associated with traditional Phillips curves. This paper establishes that sectors with standard New Keynesian price stickiness are vulnerable to rapid transitions from stickiness to flexibility, as sellers elect to reset their prices and abandon anchoring. The paper shows that the cross-industry volatility of price determinants grew substantially in the inflation episode accompanying the pandemic. Volatility remained elevated even in late 2022. The logic of the New Keynesian model of the Phillips curve links inflation to volatility, because a larger fraction of sellers are pushed out of their regions of inaction when volatility is elevated. The New Keynesian Phillips curve becomes much steeper in volatile times.
Read the paper: A Major Shock Makes Prices More Flexible and May Result in a Burst of Inflation or Deflation
