Capacity constraints, idiosyncratic demand uncertainty and the dynamics of inflation

This paper contributes to the theoretical modeling of inflation dynamics by analyzing the interplay between production inflexibilities and price setting behavior. We formalize the capacity constraint hypothesis within the context of a New-Keynesian framework. A key result shows how the dynamics of inflation depend on the distribution of utilization rates across firms in the economy. The measure of resource utilization explicitly derived here allows the study of interesting dynamics absent in current formulations of the Phillips curve.