Asymmetric Price Adjustment - Evidence For India

We construct an error correction mechanism to examine whether firms’ price adjustment is asymmetric as anticipated by Ball and Mankiw (1994). We have used monthly time series data on prices of 418 commodities, which constitute 97 percent of commodity price basket used in the construction of wholesale price index in India. The empirical evidence indicates that the price adjustment of most of the firms exhibits strong asymmetry; shocks that increases firms’ desired prices causes quicker and larger rise in prices whereas shocks that lower desired prices causes smaller or no fall in prices. Also, we identify a threshold value for each firm below which it does not allow its relative price to fall. These evidences imply that larger relative price variability can trigger inflation even in the absence of demand shocks. Moreover, the distribution of output is likely to be negatively skewed even if the demand shocks are symmetric.