Econ Seminar: Saroj Bhattarai (University of Texas Austin)

"Relative-Price Changes as Aggregate Supply Shocks Revisited: Theory and Evidence"

We provide theory and evidence that relative price shocks can lead to aggregate inflation and act like aggregate supply shocks. We show empirically that exogenous and positive oil price shocks have a positive impact not only on headline U.S. inflation but also on core U.S. inflation and a negative impact on U.S. real activity. We use a multi-sector monetary model with arbitrary input-output linkages and heterogeneity in price stickiness and analytically characterize how sectoral shocks propagate to the aggregate economy and across sectors. We empirically validate our analytical characterization using panel IV local projections, by showing that the responsiveness of sectoral prices to oil price shocks is in line with what is predicted by our analytical results. To highlight the importance of input-output linkages and heterogeneity of price stickiness in the dynamics and persistence of aggregate inflation, we perform an experiment in our model using the aftermath of COVID-19 to show that even in the absence of aggregate slack, relative price changes can generate persistent aggregate inflation movements and match the behavior of headline and core inflation.