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Menu Costs, Relative Prices, and Inflation: Evidence for Canada

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Author Info
Robert A. Amano
R. Tiff Macklem

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Abstract

Authors' note: Subsequent to completing this Working Paper, we realized that the way we constructed the weighted relative prices, ri, as described on page 8, is not invariant to the rate of inflation and this introduces a bias in favour of the menu-cost hypothesis. Preliminary results with a correction to this problem reveal that it affects the quantitative results. We are currently revisiting our empirical analysis more completely to consider the quantitative and qualitative implications of removing this bias. The menu-cost models of price adjustment developed by Ball and Mankiw (1994;1995) predict that short-run movements in inflation should be positively related to the skewness and the variance of the distribution of disaggregated relative-price shocks in each period. We test these predictions on Canadian data using the distribution of changes in disaggregated producer prices to measure the skewness and standard deviation of relative-price shocks. We find the Canadian data, both in the context of partial correlations and standard price Phillips curve equations, are highly supportive of the predictions that arise from the menu-cost models. Indeed, we find that the positive relationship between inflation and the skewness of the distribution of relative-price shocks is one of the most robust features of the Canadian Phillips curve and significantly improves our ability to explain inflation dynamics.

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Paper provided by Bank of Canada in its series Working Papers with number 97-14.

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Length: 45 pages
Date of creation: 1997
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Handle: RePEc:bca:bocawp:97-14

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Related research
Keywords: Inflation and prices; Monetary policy framework;

Find related papers by JEL classification:
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Duguay, Pierre, 1994. "Empirical evidence on the strength of the monetary transmission mechanism in Canada: An aggregate approach," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 39-61, February. [Downloadable!] (restricted)
  2. Wu, De-Min, 1973. "Alternative Tests of Independence Between Stochastic Regressors and Disturbances," Econometrica, Econometric Society, vol. 41(4), pages 733-50, July. [Downloadable!] (restricted)
  3. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May. [Downloadable!] (restricted)
    Other versions:
  4. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1981-2), pages 381-442. [Downloadable!]
  5. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  6. Prakash Loungani & Phillip Swagel, 1995. "Supply-side sources of inflation: evidence from OECD countries," International Finance Discussion Papers 515, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  7. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June. [Downloadable!] (restricted)
  8. Ball, Laurence & Mankiw, N Gregory, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 161-93, February. [Downloadable!] (restricted)
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  9. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November. [Downloadable!] (restricted)
  10. Michael F. Bryan & Stephen G. Cecchetti, 1996. "Inflation and the Distribution of Price Changes," NBER Working Papers 5793, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Robert J. Gordon, 1975. "Alternative Responses of Policy to External Supply Shocks," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1975-1), pages 183-206. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Andrés Langebaek & Eliana González M., 2007. "Inflación Y Precios Relativos En Colombia," BORRADORES DE ECONOMIA 004248, BANCO DE LA REPÚBLICA. [Downloadable!]
    Other versions:
  2. María Ángeles Caraballo & Carlos Dabús., 2008. "The Determinants of Relative Price Variability: Further Evidence from Argentina," Cuadernos de Economía (Latin American Journal of Economics), Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 45(132), pages 235-255. [Downloadable!]
  3. Jörg Döpke & Christian Pierdzioch, 2001. "Inflation and the Skewness of the Distribution of Relative Price Changes: Empirical Evidence for Germany," Kiel Working Papers 1059, Kiel Institute for the World Economy. [Downloadable!]
  4. María Ángeles Caraballo & Carlos Usabiaga, 2006. "Análisis Desagregado de la Inflación: Una Aplicación Regional," Economic Working Papers at Centro de Estudios Andaluces E2006/07, Centro de Estudios Andaluces. [Downloadable!]
  5. Carlos Usabiaga & María Ángeles Caraballo, 2004. "Inflation and Nominal Rigidities in Spanish Regions: The Ball and Mankiw Approach," ERSA conference papers ersa04p12, European Regional Science Association. [Downloadable!]
  6. Mª Ángeles Caraballo Pou & Carlos Dabús & Diego Caramuta, 2006. "A Non-linear "Inflation-Relative Prices Variability" Relationship: Evidence from Latin America," Economic Working Papers at Centro de Estudios Andaluces E2006/09, Centro de Estudios Andaluces. [Downloadable!]
  7. María Ángeles Caraballo & Carlos Usabiaga, 2006. "The Relevance of Supply Shocks for Inflation: The Spanish Case," Economic Working Papers at Centro de Estudios Andaluces E2006/17, Centro de Estudios Andaluces. [Downloadable!]
    Other versions:
  8. Mª Ángeles Caraballo Pou & Carlos Dabús, 2005. "Nominal rigidities, relative prices and skewness," Economic Working Papers at Centro de Estudios Andaluces E2005/17, Centro de Estudios Andaluces. [Downloadable!]
  9. Andrés Langebaek R. & Eliana González Molano, . "Inflación Y Precios Relativos En Colombia," Borradores de Economia 459, Banco de la Republica de Colombia. [Downloadable!]
  10. Ángel Estrada & Ignacio Hernando, 1999. "Microeconomic Price Adjustments and Inflation: Evidence from Spanish Sectoral Data," Banco de España Working Papers 9921, Banco de España. [Downloadable!]
  11. Maria A. Caraballo & Carlos Usabiaga, 2006. "Inflation and Supply Shocks in Spain: A Regional Approach," ERSA conference papers ersa06p335, European Regional Science Association. [Downloadable!]
  12. Constantina Kottaridi & Diego Mendez-Carbajo & Dimitrios Thomakos, 2007. "Inflation Dynamics and the Cross-Sectional Distribution of Prices in the E.U. Periphery," Working Papers 0004, University of Peloponnese, Department of Economics. [Downloadable!]
    Other versions:
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