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Inflation and the Distribution of Price Changes

  • Michael F. Bryan
  • Stephen G. Cecchetti

its higher order moments, and in particular, its third moment the skewness of the price change distribution. Evidence on correlations between inflation and its moments goesback over thirty years, and was first used to reject the independence of relative price changes and inflation that is assumed in neo- classical models. More recently, New Keynesian macroeconomists have shown that the strong positive correlation between inflation and the skewness of the price change distribution is consistent with menu-cost models of price setting behavior. This is a fairly controversial result, prompting other researchers to demonstrate that the same correlation can be found in a multi- sector, flexible-price (real business cycle) model. We examine the small-sample properties of the main empirical finding on which this work is based: the positive correlation between the sample mean and sample skewness of price change distributions. Our results show that this particular statistic suffers from a large positive small-sample bias, and demonstrate that the entirety of the observed correlation can be explained by this bias. To the extent that we find any relationship at all, it is that the correlation is negative. In other words, we establish that one of the most accepted stylized facts in the literature on aggregate price behavior, that inflation and the skewness of the price change distribution are positively linked, need not be a fact at all.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5793.

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Date of creation: Oct 1996
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Publication status: published as Review of Economics and Statistics, Vol. 81 (May 1999): 188-196.
Handle: RePEc:nbr:nberwo:5793
Note: ME
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  1. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  2. Nathan S. Balke & Mark A. Wynne, 1996. "An equilibrium analysis of relative price changes and aggregate inflation," Working Papers 9609, Federal Reserve Bank of Dallas.
  3. Richard De Abreu Lourenco & David Gruen, 1995. "Price Stickiness and Inflation," RBA Research Discussion Papers rdp9502, Reserve Bank of Australia.
  4. Stephen G. Cecchetti, 1996. "Measuring Short-Run Inflation for Central Bankers," NBER Working Papers 5786, National Bureau of Economic Research, Inc.
  5. Vining, Daniel R, Jr & Elwertowski, Thomas C, 1976. "The Relationship between Relative Prices and the General Price Level," American Economic Review, American Economic Association, vol. 66(4), pages 699-708, September.
  6. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  7. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
  8. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, May.
  9. Laurence Ball & N. Gregory Mankiw, 1992. "Relative-Price Changes as Aggregate Supply Shocks," NBER Working Papers 4168, National Bureau of Economic Research, Inc.
  10. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
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