RELATIVE-PRICE CHANGES AS AGGREGATE SUPPLY SHOCKS

This paper proposes a theory of supply shocks, or shifts in the short- run Phillips curve, based on relative-price changes and frictions in n ominal price adjustment. When price adjustment is costly, firms adjust to large shocks but not to small shocks, and so large shocks have dis proportionate effects on the price level. Therefore, aggregate inflati on depends on the distribution of relative-price changes: inflation ri ses when the distribution is skewed to the right, and falls when the d istribution is skewed to the left. We show that this theoretical resul t explains a large fraction of movements in postwar U.S. inflation. Mo reover, our model suggests measures of supply shocks that perform bett er than traditional measures, such as the relative prices of food and energy.