Relative Price Dispersion and the Rate of Inflation: The Evidence from Japan

Relative Price Dispersion and the Rate of Inflation: The Evidence from Japan

The relationship between inflation and price variability has been of interest to economists for many years. Recently, Ball and Mankiw [1995] have proposed a menu-cost model of price stickiness in which the skewness of relative price inflation matters as well as the standard deviation. In this paper their model is tested on Japanese wholesale price data. The results are mixed. When we use the single equation approach of Ball and Mankiw the results appear to favour their model. However, once we condition inflation on the growth in the money stock and allow for the simultaneity of inflation and relative price variability predicted by a Lucas type misperceptions model, then the effects postulated by Ball and Mankiw largely disappear, while inflation seems to drive both the standard deviation and skewness of relative prices. (JEL Classification: E3, F41)