Working Paper

Relative Price Shocks and Inflation

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.

Keywords: Monetary Policy; sectoral shocks; inflation shortfall; COVID-19;

JEL Classification: E31; E52; E58;

https://doi.org/10.21144/wp22-07

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2022-05

Number: 22-07