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Inflation and Relative Price Dispersion in Canada: An Empirical Assessment

  • André Binette
  • Sylvain Martel
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    The authors investigate empirically the relationship between different aspects of inflation and relative price dispersion in Canada using a Markov regime-switching Phillips curve. They examine three theories that explain movements in relative price dispersion: the signal extraction model, the extension of the signal extraction model, and the menu cost model. The authors show that expected inflation, which is captured by the menu cost model, is the aspect of inflation that is most closely associated with relative price dispersion. Furthermore, this result seems robust to different specifications. The authors, however, cannot completely discard inflation uncertainty (the signal extraction model), especially when using core inflation. They also observe a strong asymmetry regarding the impact of positive and negative unexpected inflation on relative price dispersion using total inflation, but this asymmetry is not observed for core inflation. This suggests that the strong asymmetry arises mainly from the presence of components typically associated with supply shocks, and not from the presence of downward nominal rigidities, as Aarstol (1999) proposes, following Ball and Mankiw (1992a,b).

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    Paper provided by Bank of Canada in its series Working Papers with number 05-28.

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    Length: 37 pages
    Date of creation: 2005
    Date of revision:
    Handle: RePEc:bca:bocawp:05-28
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    2. Allan D. Brunner & Gregory D. Hess, 1990. "Are higher levels of inflation less predictable? A state-dependent conditional heteroskedasticity approach," Finance and Economics Discussion Series 141, Board of Governors of the Federal Reserve System (U.S.).
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    4. Francis Vitek, 2002. "An Empirical Analysis of Dynamic Interrelationships Among Inflation, Inflation Uncertainty, Relative Price Dispersion, and Output Growth," Working Papers 02-39, Bank of Canada.
    5. Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
    6. Taylor, John B., 1981. "On the relation between the variability of inflation and the average inflation rate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 57-85, January.
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    26. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
    27. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 381-442.
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