ASYMMETRIC EFFECTS OF ECONOMIC-ACTIVITY ON INFLATION - EVIDENCE AND POLICY IMPLICATIONS

Data for the G-7 countries strongly support the view that economic act ivity has a nonlinear effect on inflation, with high levels of activit y raising inflation by more than low levels decrease it. In the face o f such asymmetries, the average level of output in an economy subject to demand shocks will be below the level of output at which there is n o tendency for inflation to rise or fall, contrary to linear model pre dictions. One implication is that policymakers can raise the average l evel of output over time by responding promptly to demand shocks, redu cing the variance of output around trend.