Relative Prices, Price Level and Inflation: Effects of Asymmetric and Sticky Adjustment

The paper examines how relative price shocks can affect the price level and then inflation. Using Indian \ndata we find: (i) price increases exceed price decreases. Aggregate inflation depends on the distribution \nof relative price changes—inflation rises when the distribution is skewed to the right, (ii) such \ndistribution based measures of supply shocks perform better than traditional measures, such as prices of \nenergy and food. They moderate the price puzzle, whereby a rise in policy rates increases inflation, and \nare significant in estimations of New Keynesian aggregate supply, (iii) an average Indian firm changes \nprices about once in a year; the estimated Calvo parameter implies half of Indian firms reset their \nprices in any period, and 66 percent of firms are forward looking in their price setting. The implication \nof these estimated real and nominal price rigidities for policy are drawn out.