BUSINESS-CYCLE SOURCES AND PRICE LEVEL-OUTPUT CORRELATION

This paper shows that predominantly aggregate demand- (supply-) driven output fluctuations are consistent with a negative (positive) correlation between the price level and output, but only if aggregate supply is flatter (steeper) than aggregate demand. These results bold even with zero covariance between demand and supply shocks, and these confluences are more likely to occur for algebraically higher values of the correlation between demand and supply shocks. Thus care should be taken in using observed signs of price level-output correlations to draw inferences about the validity of supply- or demand-based macro theories.