On the Asymmetric U-Shaped Relationship between Inflation, Inflation Uncertainty and Relative Price Skewness in the UK

16 Pages Posted: 8 Jul 2011 Last revised: 14 Jul 2012

See all articles by Kausik Chaudhuri

Kausik Chaudhuri

University of Leeds - Leeds University Business School (LUBS); Leeds University Business School (LUBS) - Division of Economics

Matthew Greenwood-Nimmo

University of Melbourne; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Minjoo Kim

University of Glasgow

Yongcheol Shin

Independent

Date Written: March 8, 2012

Abstract

We investigate asymmetries in the relationship between the cross-sectional mean (aggregate) rate of inflation and the second and third central moments of the cross-sectional distribution of relative prices by means of a modified Calvo pricing model with regime-dependent price rigidities. We assume that price rigidity is more pronounced when price exceeds marginal cost, a situation that we identify with weak competition and market power. Calibration experiments using realistic parameterisations reveal that the inflation-standard deviation and inflation-skewness relationships exhibit pronounced U-shaped asymmetries around the historical mean rate of inflation. UK sectoral inflation data supports our results, and indicates that our inclusion of regime-switching rigidities is important in providing an accurate characterisation of the higher moments of the distribution of sectoral price changes. We conclude that monetary policy should be designed to exploit these U-shaped relationships by targeting a level of inflation proximate to the (common) turning point. Furthermore, we conclude that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments of the distribution of price changes.

Keywords: Inflation, Regime-Dependent Price Rigidity, Sectoral Heterogeneity, UK

JEL Classification: E31, E52

Suggested Citation

Chaudhuri, Kausik and Greenwood-Nimmo, Matthew and Kim, Minjoo and Shin, Yongcheol, On the Asymmetric U-Shaped Relationship between Inflation, Inflation Uncertainty and Relative Price Skewness in the UK (March 8, 2012). Journal of Money, Credit, and Banking, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1880192 or http://dx.doi.org/10.2139/ssrn.1880192

Kausik Chaudhuri

University of Leeds - Leeds University Business School (LUBS) ( email )

Leeds LS2 9JT
United Kingdom

Leeds University Business School (LUBS) - Division of Economics ( email )

Leeds LS2 9JT
United Kingdom

Matthew Greenwood-Nimmo (Contact Author)

University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Minjoo Kim

University of Glasgow ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

Yongcheol Shin

Independent

No Address Available

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