Does inflation asymmetrically affect relative price variability?

Abstract

The U-shaped relationship between inflation and price dispersion around nonzero inflation rate is due to the use of aggregate measure of relative price variability (RPV), which amounts to specification errors in a piecewise linear regression models. However, the true underlying relationship between inflation and inflation-induced RPV is found to be U-shaped around zero inflation and inflation seems to have asymmetric impact on price dispersion as predicted by menu cost models.

Keywords:

• relative price variability
• decomposition
• asymmetry
• U-shaped relationship

JEL Classification:

• E30
• E31
• E52

Notes

¹ Clements and Nguyen (1982) report that on an average around 75% of RPV can be attributed to real factors for Australia, and Ram (1990) found that in the United States, almost half of RPV is due to real factors.

² The share of interaction of real and inflation in is Both and are adjusted for . The proportion is attributed to inflation and the proportion to real factors. These shares are multiplied with aggregate RPV to obtain the corresponding values of RPV due to inflation and real factors, in the empirical analysis.

³ We focus only on the symmetry of contemporaneous effect.

⁴ Mathematically, it means converting a standard form quadratic function into vertex form by shifting the axis from zero to the vertex.

⁵ In the similar vein as argued by Choi and Kim (2010). For details, see their graphical description on this misspecification. Further, the use of a threshold inflation rate might be problematic as Nautz and Scharff (2012) show that RPV is minimum for a range of inflation.

⁶ Following Choi and Kim (2010), average inflation rate for the sample period is used as