DP959 Price Inertia and Production Lags
The paper shows how prolonged price inertia can arise in a macroeconomic system in which there are temporary price rigidities as well as production lags in the use of intermediate goods. In this context, changes in product demand -- generated, say, by changes in the money supply -- have long-lasting price and quantity effects. Specifically, a temporary demand shift generates `persistence' in price-quantity decisions, in the sense that the price-quantity effects of this shift persist for long after the shift has disappeared. A permanent demand shift generates `sluggishness' in price-quantity decisions, in the sense that the full price effects of the shift take a long time to appear and that meanwhile quantity effects are present.