Relative Price Shocks and Inflation

In ation is determined by interaction between real factors and monetary policy. Among the most important real factors are shocks to the supply and demand for dierent components of the consumption basket. We use an estimated multi-sector New Keynesian model to decompose the behavior of U.S. in ation into contributions from sectoral (or "relative price") shocks, monetary policy shocks, and aggregate real shocks. The model is estimated by maximum likelihood with U.S. data for the post-1994 period in which in ation and the monetary policy regime appeared to be stable. In addition to providing a broad decomposition of in ation behavior, we enlist the model to help us understand the in ation shortfall from 2012 to 2019, and the dramatic in ation movements during the COVID pandemic.