The Asymmetric Effects of Demand
International Evidence on Determinants
International Monetary Fund
700 Nineteenth Street
Washington D.C. 20431
January 31, 2003
The analysis focuses on the asymmetric effects of demand shocks. The evidence
across a sample of nineteen industrial countries differentiates the effects of
expansionary and contractionary aggregate demand shocks on real output growth and
nominal wage and price inflation. The difference appears consistent with a kinked
supply curve that is dependent on the asymmetric flexibility of wages and/or prices
across countries. Furthermore, the evidence does not support the endogeneity of
asymmetric nominal flexibility with respect to demand variability or trend price
inflation across countries. On average, across countries, demand variability increases
nominal wage and price inflation relative to deflation, while exacerbating output
contraction relative to expansion. The apparent tradeoff between changes in real and
nominal trends provides further support to the supply side explanation of asymmetry.
Recent research on business cycles has produced evidence that demonstrates the
asymmetric effects of monetary shocks on economic variables.1 Specifically, the
effect of expansionary monetary shocks on economic variables may be different from
that of contractionary shocks. The empirical evidence has stimulated efforts to
provide an adequate theoretical explanation of observed asymmetry. Sources of
asymmetry have varied sharply in the theoretical literature. Primary explanations may
be classified into supply-side and demand-side sources.
A strand of the theoretical literature has viewed asymmetry of economic fluctuations
to be a supply-side phenomenon. Demand shifts along a kinked supply curve are
likely to produce varying effects on the economy. In one direction, some have
explained the asymmetric shape of the supply curve by conditions in the labor market.
The stipulation of wage contracts may allow for asymmetric wage indexation. For
example, if wages are more upwardly flexible, the aggregate supply curve is steeper
in the face of expansionary demand shocks compared to contractionary shocks.2
1Cover (1992) and Kandil (1996) illustrate the evidence using data for the United
States. Kandil (1995) demonstrates the asymmetric effects of demand shocks using
quarterly data for real output, the nominal wage and the price level across industrial
countries. Other research on asymmetry includes De Long and Summers (1988) and
Romer and Romer (1989). Karras (1996a) and (1996b) demonstrate the asymmetric
effects of monetary shocks using annual data for output and price. Kandil (1998)
demonstrates the non-neutrality of aggregate demand shocks using aggregate data for
a sample of developing and developed countries. Kandil (1999) demonstrates the
asymmetric stabilizing effects of price flexibility using pre- and post-war data for a
sample of industrial countries. Weise (1999) tests the asymmetric effects of monetary
policy using a VAR-based model. Kandil (2001) and (2002a) demonstrate asymmetry
in the effects of government spending shocks using quarterly data for the United
States. Kandil and Mirzaie (2002) investigate possible asymmetry in the effects of
exchange rate fluctuations on sectoral output and price in the United States.
2For more details on this theoretical possibility, see Cover and Van Hoose (1993) and
Kandil (2002b). Insider-outsider models attempt an alternative explanation for
asymmetric nominal wage adjustments (see, for example, Lindbeck and Snower
(1986) and Blanchard and Summers (1988)).
Alternatively, supply-side asymmetry may be attributed to conditions in the product
market. Faced with menu costs, firms may be inclined for more frequent and larger
adjustments of prices in the upward direction compared to the downward direction.
This scenario is consistent with a steeper supply curve in the face of positive demand
shocks compared to negative shocks.3
Another line of theoretical explanations has emphasized possible asymmetry on the
demand side of the economy. Conditions in the money and/or the goods markets may
differentiate the response of aggregate demand to positive and negative shocks.4 This
possibility differentiates the shift of the aggregate demand curve in the face of
expansionary and contractionary shocks.
Supply-side asymmetry produces a trade-off between the asymmetric effects of
demand shocks on output growth and their inflationary effects on wages and/or prices.
In contrast, demand-side asymmetry produces a positive correlation between the
asymmetric effects of demand shocks on real output growth and nominal wage and
The purpose of this investigation is to contribute to the existing literature on
asymmetry by establishing the relevant evidence to identify the source of asymmetry:
supply- and/or demand-side asymmetry. To that end, the investigation evaluates the
asymmetric effects of aggregate demand shocks and several specific underlying
components on real output growth and nominal wage and price inflation across a
sample of nineteen industrial countries. Using time-series estimates for various
variables within countries, the investigation evaluates the possible endogeneity of
asymmetry with respect to trend price inflation and/or demand variability across
The results reveal asymmetry in the effects of aggregate demand shocks for some of
the countries under investigation. The direction of asymmetry appears, however,
mixed between a steeper supply curve in the face of expansionary shocks or
contractionary shocks. In addition, the size of aggregate demand shifts maybe
different with respect to expansionary and contractionary specific underlying shocks.
Further, the evidence rejects the hypothesis that trend price inflation and/or demand
variability determines the observed difference in asymmetry across countries.
The remainder of the paper is organized as follows. Section II presents analytical
relationships for empirical investigation. Section III describes the data and empirical
models. Section IV discusses the time-series empirical evidence. Section V analyzes
variation in the time-series evidence across countries. Finally, Section VI offers a
summary and conclusions.
II. Analytical Relationships
To illustrate sources of asymmetry,5 consider the following relationship:
D is the first-difference operator. The log of real output is denoted by y ,
where p and w denote the log values of the price level and the nominal wage.
Dnsjy p w
3For more details on this theoretical possibility see Caballero and Engle (1991),
Caplin and Leahy (1991), Tsiddon (1991) and Ball and Mankiw (1994).
4Examples are models of credit rationing policies (see, e.g., Bernanke (1983)).
5For related illustrations, see Karras (1996b).
Average growth, in full-equilibrium, is denoted by
average are attributed to random shocks in the economic system. Changes of real
output, the price level and the wage rate in period t are expressed as a function of
unanticipated aggregate demand growth,
Dns , where
Aggregate demand shocks are distributed between output growth and price inflation
. The slope of the labor supply curve may determine the
output-inflation tradeoff in the face of aggregate demand shocks. Tight conditions in
the labor market increase wage flexibility with respect to aggregate demand shocks.
The steeper the supply curve is, the smaller
aggregate demand shocks. Higher nominal wage flexibility reinforces the inflationary
effect of aggregate demand shocks on price and moderates their expansionary effect
on real output. That is,
are positively correlated; they correlate negatively
Unanticipated aggregate demand shocks can be differentiated, however, into positive
and negative shocks:
neg denote positive and negative shocks to aggregate demand
growth. Demand shocks are distributed symmetrically over time.9 That is, the average
neg is equal, in absolute value. Nonetheless,
Supply-side explanations attribute the source of asymmetry to a kinked-shape of the
aggregate supply curve. In one direction, some (see, for example, Kandil (2002b))
have explained the asymmetric shape of the supply curve by conditions in the labor
market. In a framework in which nominal wage and salary negotiations are governed
by contractual agreements, the degree of wage indexation may be different in
response to expansionary and contractionary demand shocks. Asymmetric flexibility
may be the result of institutional settings that differentiate nominal wage and salary
negotiations in the upward and downward directions.10 Alternatively, asymmetric
constant .6 Deviations around this
denotes the effect on the
and the larger
in response to
posnegjy p w
6The mean growth rate is determined by productive resources, e.g., technical progress
and population growth.
7The relationship in (1) is implied by the reduced-form solutions in standard business-
cycle models that incorporate the rational expectation hypothesis. These include
equilibrium business-cycle models pioneered by Lucas (1973) and new Keynesian
models advocating nominal wage rigidity, for example (Fischer (1977)), or price
rigidity, for example (Ball, Mankiw and Romer (1988)).
8 This correlation is the basic premise of theoretical models that emphasize wage
rigidity in the labor market as an explanation of business cycles.
9The analysis focuses on asymmetry in the effects of the shocks, i.e.,
a theoretical illustration of variation in the degree of asymmetry with the size of the
neg , see Evans (1985).
10During boom periods, cost of living adjustments may be specified to guarantee
workers upward adjustment of wages to keep up with inflation. In contrast, firms may
be reluctant to take aggressive measures towards adjusting wages in the downward
direction. This is because the search and training cost of hiring new workers to
flexible wages may be an endogenous response to uncertainty impinging on the
economic system. Models of the variety of Gray (1978) have emphasized the
dependency of the degree of indexation on the variability of stochastic disturbances.
Higher demand variability may signal future inflationary risk, increasing agents’
incentives for the upward adjustment of wages. If demand variability is larger for
positive shocks compared to negative shocks, upward nominal flexibility exceeds
downward flexibility. Similarly, in economies with a history of high trend inflation,
agents’ incentives are likely to be larger for upward wage flexibility compared to
An alternative explanation of supply-side asymmetry (see, for example, Ball and
Mankiw (1994)) is based on menu costs; the cost and effort involved in changing
prices. Inflation causes firms’ relative prices to decline automatically between price
adjustments. When a firm wants a lower relative price (in the face of contractionary
demand shocks), inflation does much of the work, decreasing the need to pay the
menu cost. By contrast, an expansionary demand shock, coupled with high inflation,
means that firm’s desired relative price rises while its actual relative price is falling.
As trend price inflation increases, positive shocks are more likely to induce a larger
price adjustment compared to negative shocks.
Both the sticky-wage and sticky-price explanations are consistent with a kinked
supply curve. The kink occurs at zero unanticipated demand shock, i.e.,
in (2). If the supply curve is steeper in the face of
positive demand shocks compared to negative shocks (see Figure 1), for equal size
The shape of the supply curve implies a tradeoff between the asymmetric effects of
aggregate demand shocks on real output growth and price inflation. Larger price
inflation compared to deflation,
, correlates with larger output contraction
relative to expansion,
. In addition, the sticky-wage explanation establishes
the importance of wage asymmetry to the shape of the supply curve, implying higher
upward wage flexibility compared to downward flexibility.
Aggregate demand shocks are induced, in turn, by specific shocks that underlie
aggregate demand. This requires rewriting equations (1) and (2) as follows:
jy p w
d c i g x
t pjdt njdt
Djposnegjy p w
d c i g x
Changes in real output, the price level, and the wage rate are induced by specific
accommodate a future rise in demand may actually exceed the perceived loss of
retaining workers at wages that exceed the marginal physical product of labor during
shocks that underlie the growth of aggregate demand,
Dcs , investment shocks,
Dgs , or export shocks,
demand. Note that
varies with the slope of the aggregate supply curve,
size of the aggregate demand shift in response to the specific underlying shock,
In equation (4), the positive and negative shocks to specific demand are denoted by
neg . The magnitudes in curly brackets measure the size of the aggregate
demand shift with respect to positive and negative shocks to the underlying
component. A larger aggregate demand shift in response to negative shocks increases
the contractionary effects on real output growth and the deflationary effects on wages
and prices, compared to that of positive shocks.
In Figure 2, larger output contraction compared to expansion,
with larger price deflation compared to inflation,
Structural and institutional parameters may differentiate the elasticity of aggregate
demand and, therefore, the size of aggregate demand shifts with respect to positive
and negative specific demand shocks. Bernanke (1983) discusses the presence of
credit constraints which differentiate banks’ willingness to lend during booms and
recessions. During recessions, a higher risk of borrowers’ bankruptcy prompt banks to
ration credit. This credit constraint exacerbates the contractionary effect of a
slowdown in spending during a recession. In contrast, credit constraints are not
binding during a boom period. Nonetheless, banks’ willingness to lend may not
stimulate an increase in spending without an increase in the demand for credit.11
Shocks to aggregate demand,
Dns , are distributed with a zero mean and a constant
variance. The larger the variance is, the larger the size of positive,
neg , demand shocks. Assuming aggregate demand shocks are symmetric,
on average, and their effects are symmetric,
aggregate demand shocks is neutral on trend real output, price, and the nominal wage.
In contrast, assuming symmetric aggregate demand shifts along a steeper supply
curve, for example, in the face of positive demand shocks, demand variability will
have a net average positive contribution (inflation) to price and a net average negative
contribution (contraction) to output over time. If the steeper supply curve is dependent
on a higher upward flexibility of the nominal wage in the labor market, wage inflation
increases, on average, in the face of symmetric aggregate demand shifts over time.
Accordingly, demand variability increases the trends of wage and price inflation and
decreases trend real output growth, on average over time.
In the absence of supply-side asymmetry and assuming
Dds , for example, private
Dis , government consumption
measures the effect of the shock to specific
, and the
pos and negative,
, the variability of
11Jackman and Sutton (1982) set a similar argument by focusing on the effect of
interest rate changes on spending. They report that as interest rates rise (in response,
e.g., a tight monetary policy, consumption spending falls the full amount as a result of
the increase in debt payments. In contrast, a decrease in interest rates (in response,
e.g., an expansionary monetary policy) induce higher levels of spending, but by an
amount less than the change in liabilities. Similarly, Bernanke and Gertler (1989)
analyze the relation between changes in the interest rate and investment demand.
They find that large drops in investment are more likely to occur than large increases.
asymmetric on average, demand variability produces different results. Assuming a
larger expansion of aggregate demand relative to contraction, demand variability will
have a net average positive effect (inflation) on wages and prices and a net average
positive effect (expansion) on output over time. Accordingly, demand variability
increases the trends of wage and price inflation as well as trend output growth, on
average over time.
III. Data and Econometric Methodology
To study asymmetry in the shape of the aggregate supply curve, the empirical models
track the response of output growth and price inflation to positive and negative
aggregate demand shocks. To study the relevance of conditions in the labor market to
the shape of the aggregate supply curve, the econometric investigation analyzes
asymmetry in the response of nominal wage inflation to positive and negative
aggregate demand shocks.
A sample of nineteen industrial countries is under investigation. Annual data for these
countries are available over the sample period 1960-2000.12 Description of variables
and data sources are provided in Appendix B.
The empirical models for real output growth, price inflation, and wage inflation
replicate the reduced form equations in a standard business-cycle macroeconomic
model. The solutions establish that fluctuations in the output and the labor markets
vary with demand and supply shifts impinging on the economic system. Assuming
rational expectations, demand and supply shifts are decomposed into anticipated and
Structural constraints determine the distribution of supply shifts, both anticipated and
unanticipated, between output growth and price inflation. In contrast, agents adjust
nominal values, wages and prices, to absorb anticipated demand shifts fully,
insulating real output growth from these shifts. Further, the slope of the short-run
supply curve determines the distribution of unanticipated demand shifts between
output growth and price inflation.
To study possible asymmetry in the shape of the short-run supply curve, shocks to
aggregate demand are decomposed into positive and negative shocks that are
distributed symmetrically around a steady state random trend. Using annual data,
shocks approximate a composite collection of accumulated shocks within a year.
The first step of the empirical investigation is to specify the process guiding agents’
forecasts of aggregate demand. Let
aggregate demand). The process that guides agents’ forecasts includes two lags of
realized values of variables that determine the growth of aggregate demand in theory
the log of the aggregate price level (the GDP deflator),
information to agents’ forecasts, the fitted value of the empirical model in (5) denotes
tn denote the log of nominal GDP (a proxy for
ti is the short-term interest rate,
ty is the log of real output (real GDP),
tg is the log of government
t m is the log of the money supply. Having filtered out the relevant
12 Quarterly data are not available for all variables over this span.
anticipated aggregate demand growth.13 The shock to aggregate demand growth is a
pure random white noise residual,
Dns . Test results satisfy the rationality
requirements as follows. First, the residual in equation (5) is a pure white noise. This
is evident by lack of serial correlation, implying economic agents are not making
systematic forecasting errors. Second, the residual is uncorrelated with right-hand side
variables in (5), implying economic agents have capitalized on available information
Shocks to the growth of aggregate demand have a symmetric distribution around its
zero average, by construction. Given the interest to study the asymmetric effects of
demand shocks, shocks to aggregate demand are separated into their positive and
negative components, following the suggestions of Cover (1992), as follows:
expansion and contration, respectively.
Equation (5) is estimated jointly with equations that describe real output growth, price
inflation, and nominal wage inflation, as follows:
Dy E DqDy
DpE Dq E Dn
Dw E DqE Dn
Following the suggestions of Nelson and Plosser (1982), the appropriate
representation of non-stationarity is under investigation. Following the seminal work
of Dickey and Fuller (1981, the trend components of real output, the price level and
the wage rate follow a stochastic trend that can be approximated by a random walk
process (see details in Table A1). The stochastic trend is the domain of real growth
factors, including technology and labor force, that determine stochastic growth over
time. To render the series stationary, the empirical models are specified in first-
In addition to aggregate demand shifts, supply-side shifts determine conditions in the
output and labor markets. Movements in the energy price capture major supply-side
shifts.15 Agents’ forecasts of the energy price follow an autoregressive process with a
structural break around the major shock in 1973 (see Appendix A for details).
Anticipated change in the energy price is
energy price shock.
Assuming neutrality, anticipated aggregate demand shifts are absorbed fully in
nominal magnitudes, wage and price, with no effect on real output. Accordingly,
13Theoretical explanations have focused on asymmetry in the propagation mechanism
of unanticipated shocks. In contrast, agents adjust fully to anticipated shifts, which
renders the explanation of asymmetry, in general, unapplicable.
14Detailed results are available upon request.
15Nominal GNP or GDP approximates the total value of aggregate spending on goods
and services in the economy. It is likely, however, that this measure is affected by
major supply-side factors. To trace the shifts of the AD curve for a given constant AS
curve, it is important, therefore, to account for major sources of supply-side shifts,
e.g., the energy price.
abs is the absolute value operator, where
neg denote demand
twwttwtt pwnt nwntwtwt
Dqs is the unanticipated
persistence in output adjustments, the lagged value of real output growth is included
in the empirical model.16 Unexplained random residuals are denoted by
Changes in the energy price, both anticipated and unanticipated, are expected to have
negative effects on real output growth. The parameter
persistence characterizing real output growth. The parameters
the expansionary and contractionary effects of aggregate demand shocks.17
Changes in the energy price, both anticipated and unanticipated, are expected to
increase nominal wage and price inflation. Anticipated aggregate demand shifts are
expected to have positive effects on nominal wage and price inflation. The larger
these parameters, the faster is the speed of nominal wage and price adjustment
towards their full equilibrium values. The parameters
upward and downward flexibility of price inflation in response to aggregate demand
shocks.18 Similarly, the parameters
and downward flexibility of nominal wage inflation in response to aggregate demand
In addition to the analysis of supply-side asymmetry, the investigation will shed light
on possible asymmetry in the response of aggregate demand to specific underlying
shocks. To test for possible asymmetry in the size of aggregate demand shifts,
regressed on the positive and negative components of specific demand shocks as
determine the size of unanticipated aggregate demand
is an unexplained residual. These parameters differentiate the
elasticity of aggregate demand in the face of specific underlying symmetric shocks.
Regression (9) will verify the presence of asymmetric aggregate demand shifts in the
face of underlying components.
The empirical models (5) through (9) are estimated jointly to establish possible
asymmetry in the response of variables in the output and labor markets to aggregate
demand shocks. This asymmetry is determined by the slope of the aggregate supply
curve, which maybe dependent on conditions in the labor market, according to the
sticky-wage explanation of business cycles. In addition, the estimation of the
empirical model in (9) will verify possible asymmetry in the response of aggregate
demand to specific underlying shocks.
The reduced form equations included constructed proxies for agents’ forecasts and
unanticipated shocks. To avoid the “generated regressor" problem, the empirical
16Many standard business-cycle models share the neutrality hypothesis. Accordingly,
anticipated demand shifts are absorbed in nominal variables without affecting real
output. By construction, anticipated demand shifts are a function of lagged changes in
wage, price, and output. This eliminates the need to account for the lagged dependent
variable in equations (7) and (8).
17Negative parameters would indicate counter-cyclical response to demand shocks.
For example, real output growth may be increasing despite recessionary demand
18Negative parameters would signal nominal rigidity. For example, price inflation
may be increasing despite recessionary demand conditions.
is suppressed in the empirical model that describes real output growth. Given
approximates the degree of
approximate the degree of upward
pn dtnn dtnt
models are estimated using 3SLS, which accounts for the covariance between the
residuals of the dependent variables and forecasted variables (see, e.g., Mishkin
(1982) and Pagan (1984)). Detailed methodology is described in Appendix A.
VI. Time-Series Empirical Results
This section summarizes the evidence of asymmetric economic fluctuations in
response to aggregate demand shocks based on estimates of the empirical models (6)
through (8). Subsequently, the section summarizes the evidence that verifies the
presence of demand-side asymmetry based on estimates in the empirical model (9).
VI-A. Supply-Side Asymmetry
Table 1 summarizes detailed estimates of the empirical models in (6) through (8). The
signs of the parameters are consistent with theoretical predictions in most cases. To
conserve space, the discussion will focus on parameters that measure the variables’
responses to expansionary and contractionary aggregate demand shocks,
The difference (
) is of a particular interest. It measures the direction of
asymmetry. Statistical significance of the difference is established at the five or ten
percent levels of a two-sided test.19
In eight of the nineteen countries, there is an asymmetry in the effect of aggregate
demand shocks on output growth which is statistically significant at the 5% level (At
the 10% level this asymmetry is exhibited in ten countries). These include both cases
in which the contractionary effect is stronger, Belgium, France, New Zealand, Spain,
and the United States, and cases in which the expansionary effect is stronger,
Denmark, Finland, Sweden, and the United Kingdom. Consistently, there is an
asymmetry in the effect of aggregate demand shocks on price inflation which is
statistically significant in all these countries. The inflationary effect is stronger in the
former group while the deflationary effect is stronger in the latter group. In all of
these cases, the evidence supports a kinked slope of the aggregate supply curve in the
face of aggregate demand shocks.
Overall, there is evidence that positive and negative shocks to aggregate demand have
asymmetric effects. The relative price flexibility in the face of positive and negative
shocks determines the direction of asymmetry. The mixed results challenge
explanations of supply-side asymmetry that suggest a steeper supply curve in the face
of expansionary demand shocks compared to contractionary shocks.20
Estimates of asymmetry in the wage equation (8) will verify if the kinked slope of the
aggregate supply curve is dependent on asymmetric flexibility in the labor market. In
seven of the nineteen countries, there is an asymmetry in the effect of aggregate
demand shocks on nominal wage inflation which is statistically significant at the 5%
level (At the 10% level this asymmetry is exhibited in eight countries). These include
both cases in which the inflationary effect is stronger, Germany, New Zealand,
Norway, and the United States, and cases in which the deflationary effect is stronger,
Austria, Denmark, Italy, and Spain.
19t-statistic is the ratio of the difference in coefficients to the square root of its
pypp ny np
. This constraint holds statistically for
While the mixed results challenge explanations of supply-side asymmetry, the
mixture is interesting for the analysis of variation across countries. The evidence
indicates that countries maybe facing different shapes of a kinked supply curve, which
may have different explanations and implications.
VI-B. Demand-Side Asymmetry
The estimation of the empirical model in (9) provides evidence regarding asymmetry
in the size of aggregate demand shifts with respect to specific underlying shocks.
The difference between
to the specific underlying shocks. The coefficient that measures the difference and its
statistical significance, as measured by t-values, are reported in Table 2.
Demand expansion exceeds contraction in the face of private consumption shocks in
Belgium and Canada. Demand contraction exceeds expansion with respect to private
consumption shocks in the Netherlands.
Demand expansion exceeds contraction with respect to investment shocks in Austria,
Germany, and Japan. Demand contraction exceeds expansion with respect to
investment shocks in Canada, France, Italy, and New Zealand.
Demand expansion exceeds contraction with respect to government consumption
shocks in Finland, Italy, and Norway. Demand contraction exceeds expansion with
respect to government consumption shocks in Canada, Denmark, and France.
Demand expansion exceeds contraction with respect to export shocks in Austria,
Ireland, Italy, and Japan. Demand contraction exceeds expansion with respect to
export shocks in Denmark.
n illustrates the direction of asymmetry with respect
V. Cross-Section Analysis
This section employs parameter estimates from the time-series models to analyze
correlations between the asymmetric effects of demand shocks on economic variables
and the implications of this asymmetry.21
Given evidence of supply and demand-side asymmetry, the correlation between the
time-series estimates across countries determines the direction and strength of
comovements in variables’ adjustments to demand shocks.22
21 The cross-section analysis employs estimates from the time-series regressions.
Point estimates approximate the average response of variables to aggregate demand
shocks over time. The cross-country regressions follow the generalized least squares
estimation method suggested by Saxonhouse (1977). To account for the variability of
time-series estimates, each parameter is weighted by the inverse of the standard
deviation in the time-series regression. That is, estimates with high standard errors
(statistically insignificant) are weighted less heavily in the cross-country analysis.
22 Correlation measures the closeness of a linear relationship between variables. A
correlation of 0 between two variables means that each variable has no linear
predictive ability for the other. The sample correlation approximates the Pearson
product-moment correlation. It is computed:
of x and y . The significance probability approximates the significance level for the
null hypothesis of a zero correlation.
( )()(()() )
xy rxx yyxxyy
where x and y are the sample means
V-A. Asymmetric Co-movements Across Variables
The time-series estimates in (6) through (8) provide evidence of a kinked supply
curve in a number of countries. Cross-country correlations will generalize the
evidence regarding comovements in the point estimates in the face of positive and
In Table 3, segment I, the correlation between the expansionary and contractionary
effects of aggregate demand shocks indicates the degree of asymmetry. Asymmetry
implies a negative correlation between the effects of positive and negative shocks.
That is, an increase in the effect of positive shocks correlates with a reduction in the
effect of negative shocks, or vice versa.23 The correlation between the effect of
positive and negative shocks on output growth is negative, -0.29. An increase in the
response of output growth to one shock, positive or negative, correlates with a
reduction in the other direction. Consistently, the correlation between price flexibility
in the upward and downward directions is negative, -0.24. Price inflation is
asymmetric in the face of positive and negative shocks. The correlation between the
upward and downward flexibility of wages is negative, -0.52, across countries.
Correlation coefficients indicate that asymmetry is the most pronounced in the labor
market. As wage inflation increases in the upward direction with respect to positive
demand shocks, nominal wage flexibility decreases with respect to contractionary
demand shocks, on average, across countries.
In Table 3, segment II, the correlation between the effects of positive demand shocks
indicates that conditions in the labor market determine the trade-off between output
expansion and price inflation in the output market. Upward flexibility of nominal
wages and prices are positively correlated with a correlation coefficient 0.53. The
large correlation indicates closeness in wage and price inflation in the face of
expansionary aggregate demand shocks across countries. The expansionary effects on
real output are negatively correlated with wage and price flexibility with coefficients -
0.96 and -0.46, respectively.24 The negative correlations indicate a high trade-off
between output expansion and upward nominal flexibility in the output and labor
markets across countries.
In Table 3, segment III, the correlation between the negative effects of demand shocks
indicates the relevance of downward nominal wage flexibility to the trade-off between
output contraction and price deflation. Downward flexibility of wages and prices are
positively correlated with a correlation coefficient that equals 0.56. This correlation
provides further support for the closeness between wage and price deflation in the
face of contractionary aggregate demand shocks across countries. Output contraction
is negatively correlated with wage and price flexibility with magnitudes -0.89 and -
0.58, respectively. The negative correlations further indicate a high trade-off between
output contraction and downward nominal flexibility, in the output and labor markets.
The above evidence indicates close negative correlations between real and nominal
adjustments to aggregate demand shocks, both positive and negative. Moreover,
asymmetry is evident in the adjustment of each variable to positive and negative
shocks across countries. To verify the trade-off between real and nominal asymmetry,
23Note that the coefficients measuring price flexibility are different across various
countries. The correlation coefficients measure how this variation, in the upward
direction, correlates with variation in the downward direction, across countries.
24By construction, aggregate demand shocks are distributed between real output
growth and price inflation.
Table 3, segment IV, presents cross-country correlations of the form
(( ) ())
. The correlation between price and wage
asymmetry is positive, 0.65. The asymmetric effects of aggregate demand shocks on
real output varies negatively with asymmetry of price and wage flexibility with
correlations -0.91 and -0.60, respectively.
The apparent tradeoff between nominal and real asymmetry indicates movements in
aggregate demand shocks along kinked supply curves. Further, asymmetry in the
labor market appears to have contributed to asymmetry in the product markets across
countries. On average, across countries, an increase in output expansion relative to
contraction correlates with lower inflation relative to deflation, and vice versa.
V-B. Determinants of Asymmetry
The above evidence establishes the importance of supply-side asymmetry. On
average, across countries, the trade-off between output growth and price inflation
varies with nominal wage flexibility in the labor market. Note, however, that the time-
series evidence suggests that the type of asymmetry is mixed; producing evidence of
both a steeper supply curve in the face of expansionary shocks or a steeper curve with
respect to contractionary shocks. That is, price flexibility maybe more pronounced
with respect to either expansionary or contractionary demand shocks in a few
countries. Given the mixed evidence, is there any merit to the argument that the
observed difference is endogenously determined across countries?
Theoretical explanations of supply-side asymmetry have advocated the possible
endogeneity of asymmetric flexibility. Higher trend inflation and/or demand
variability increases incentives for upward nominal flexibility and, therefore, the
likelihood of a steeper supply curve in the face of expansionary aggregate demand
shocks, compared to contractionary shocks. In contrast, a few countries appear to
have taken more aggressive steps towards fighting inflation, establishing a greater
This section provides evidence on variation in asymmetry with trend price inflation
and demand variability, across countries. Trend inflation is measured by the sample
average of the log first-difference of the price level. Demand variability is measured
by the standard deviation of aggregate demand shocks,
Cross-country regressions, in Table 4, indicate that wages and prices appear rigid to
adjust downward in response to higher demand variability, in regressions I.b. and II.b.
Accordingly, demand variability increases upward wage and price flexibility relative
to downward flexibility, as evident by the positive and statistically significant
parameters in regressions I.c. and II.c. across countries. Demand variability increases
output contraction relative to expansion, as evident by the negative, although
statistically insignificant, parameter in regression III.c. across countries.
Trend price inflation increases downward wage and price flexibility, as evident by the
positive and statistically significant parameters in regressions I.b. and II.b.26 Further,
trend price inflation is statistically significant in narrowing the difference between
25By construction, demand shocks are exogenous to the economic system. Data for the
cross-section analysis are provided in Table A1.
26 The highest trend inflation is evident for Spain, 11 percent on average over time,
which is characterized by a higher downward price flexibility relative to upward
flexibility in response to aggregate demand shocks (Table 1).
Dns , in the empirical
upward and downward flexibility of wages and prices, as evident by the negative and
statistically significant parameters in regressions I.c. and II.c. Consistently, trend price
inflation moderates output contraction, as evident by the negative and statistically
significant parameter across countries in regression III.b. Countries with higher trend
inflation appear, therefore, to have taken more aggressive steps to ensure downward
flexibility of wage and price inflation with respect to contractionary demand shocks.
This evidence may provide an empirical explanation for the observed “concavely"
kinked AS curves, in contrast to the theoretical hypothesis of a “convex" kinked AS
V-C. Implications of Asymmetric Fluctuations
Which is more dominant, demand or supply-side asymmetry? The time-series
evidence indicates the presence of supply-side asymmetry, which appears to be
further supported by co-movements in the time-series parameters across countries.
Demand-side asymmetry is also evident in a few countries, where the size of
aggregate demand shifts is different with respect to underlying positive and negative
specific demand shocks.
Demand variability affects economic variables through positive and negative shocks.
Asymmetry in the effects of these shocks determines the relation between demand
variability and the trends of economic variables. Trends are approximated by the
sample average of the first-difference of log variables over the time span under
To shed some light on the relevance of supply and demand channels of asymmetry,
cross-section analysis evaluates the impact of the variability of specific demand
shocks on the trends of real output growth, price inflation and nominal wage inflation.
A steeper supply curve in the face of expansionary demand shocks implies an increase
in trend inflation and a reduction in trend real output growth with demand variability,
on average, across countries. In contrast, a larger size demand shift in the face of
expansionary shocks implies a larger response of output and price to demand
expansion. Hence, demand variability increases output expansion relative to
contraction, while increasing price inflation relative to deflation, on average, across
Table 5 summarizes the results from cross-country regressions that formalize the
relations between demand variability and the trends of real output growth and wage
and price inflation across countries.
In segment I, average real output growth decreases in response to a higher variability
of private consumption shocks, investment shocks, and government consumption
shocks, although with coefficients that are statistically insignificant.
In segment II, trend price inflation increases significantly in the face of a higher
variability of private consumption shocks, government consumption shocks, and
In segment III, average wage inflation increases significantly in the face of a higher
variability of aggregate demand shocks and export shocks.
The presence of asymmetry determines that demand variability is no longer neutral on
realized trends of price inflation, wage inflation, and output growth. Across countries,
27This evidence is consistent with earlier discussion on experiences with stopping
inflation, see, e.g., Yeager (1981).
28Details are provided in Table A1 of Appendix A.
the reduction in trend output growth in the face of demand variability indicates that Download full-text
asymmetry in response to demand shocks is consistent, on average, with larger output
contraction relative to expansion. Similarly, the increase in the trends of wage and
price inflation in the face of demand variability indicates that asymmetry is consistent,
on average, with larger wage and price inflation relative to deflation across
countries.29 More importantly, the apparent trade-off between the effects of demand
variability on real and nominal trends provides a stronger support to supply-side
asymmetry compared to demand-side asymmetry.
IV. Summary and Conclusion
Previous research has explored the presence of asymmetry in the effects of demand
shocks on economic variables. This investigation has focused on the empirical
validity of competing explanations for the observed asymmetry. These explanations
can be broadly classified into supply-side and demand-side sources of asymmetry.
The time-series evidence across a sample of nineteen industrial countries indicates
asymmetry of economic fluctuations for many countries. Consistent with a kinked
supply curve, aggregate demand shocks have varying effects on real output, the price
level, and the nominal wage in a number of countries. Further, the time-series
evidence differentiates the size of aggregate demand shocks in the face of positive and
negative specific underlying shocks in a number of countries.
The time-series estimation generates a pool of point estimates that are further
analyzed to draw implications across countries. On average, the shape of the
aggregate supply curve correlates with wage flexibility in the labor market. Hence,
there is a trade-off between the asymmetric effects of aggregate demand shocks on
real output growth and the corresponding effects on nominal wage and price inflation.
The apparent trade-off supports supply-side asymmetry. In support of the sticky-wage
explanation of asymmetry, asymmetric wage flexibility varies with the slope of the
aggregate supply curve across countries.
Across countries, the evidence does not support the endogeneity of asymmetric
nominal flexibility with respect to demand variability or trend price inflation. In
contrast to theoretical predictions, trend price inflation moderates the difference
between upward and downward price flexibility. Countries with a history of high
inflation appear, to be taking more aggressive steps to stop inflation.
To verify the empirical validity of competing explanations of asymmetry, supply-side
vs. demand-side asymmetry, cross-country regressions track the effect of demand
variability on the trends of real output growth and wage and price inflation. Higher
demand variability results in higher trends of wage and price inflation, while
decreasing the trend of real output growth, on average, across countries. The apparent
trade-off between changes in real and nominal trends provides further support to the
supply-side explanation of asymmetry. On average, across countries, demand
variability increases nominal wage and price inflation relative to deflation while
exacerbating output contraction relative to expansion. Policy design should aim at
addressing the underlying causes of supply-side asymmetry to reduce the undesirable
effects of asymmetry within countries. Towards this objective, the time-series
evidence and the cross-country analysis of the present paper may prove of some
29The evidence in Table 4 indicates, however, that higher trend inflation counters the
effect of demand variability as countries attempt to slow down inflation.