P-ASTERISK-MODEL, THE PRICE ADJUSTMENT PROCESS AND INFLATION THEORY

The paper examines the lag structure of the price adjustment following a change in the long run price level P. Comparing the lag structure implied by various empirical P models with the effects derived from t he standard inflation model it is shown that the price reaction varies substantially between countries. The standard inflation model with st atic expectations, which leads to cyclical dynamics of the inflation r ate after a shock to the long run inflation rate, is supported by diff erent estimates for the U.S. and Canada. However, the examined price a djustment process is very different for several European countries and for Japan exhibiting hardly any cyclical elements in the price adjust ment path. Reasons for the different price reaction discussed in the p aper are a different type of expectation formation pattern and less fl exible wages and prices.