The paper examines how relative price shocks can affect the price level and then inflation. Using Indian data, it is observed that: (1) Price increases exceed price decreases. Aggregate inflation depends on the distribution of relative price changes—inflation rises when the distribution is skewed to the right; (2) Such distribution- based measures of supply shocks perform better than the traditional measures, such as prices of energy and food. They moderate the price puzzle, whereby a rise in policy rates increases inflation, are significant in estimations of New Keynesian aggregate supply, and show the Indian aggregate supply curve to be flat, but subject to shifts; (3) An average Indian firm changes prices about once in a year. The estimated Calvo parameter implies that half of the Indian firms reset their prices in any period, while 66% of firms are forward looking in their price setting. These estimated real and nominal price rigidities imply policy needs to anchor inflationary expectations in response to supply shocks, but policy responses must be moderate.

There is a current surge in research that investigates firm’s price setting using micro data with the goal of measuring price stickiness and understanding why prices are sticky—that is why prices adjust only gradually to shocks. A common finding of several studies is that there is a large heterogeneity in the frequency of price adjustment even within detailed categories of goods. Sticky prices have important consequences for aggregate inflation, output and policy response. A measurable statistic capturing this heterogeneity would be a useful input for discerning what the price stickiness implies for the transmission of shocks and which models of price setting best fit the data, all of which is important for designing the monetary policy. There is little evidence, however, on these aspects.

The present paper seeks first to study micro price setting in India, its heterogeneity and firms’ response to shocks. Second, it develops a statistic measuring supply shocks from the heterogeneity of firms responses. Third, it uses this measure in an aggregate supply curve that also gives an aggregate measure of price stickiness, and finally, it draws the implications for policy. Results in an Emerging Market (EM) can differ because inflation in such markets usually tends to be higher and supply shocks more frequent as compared to a mature market.

Applied Economics Journal, Effects of Asymmetric, Sticky Adjustment, Emerging Market, Wholesale Price Index (WPI).