Deflation and Relative Prices: Evidence from Japan and Hong Kong

We test the menu cost model of Ball and Mankiw (1994, 1995), which impliesthat the impact of price dispersion on inflation should differ between inflation anddeflation episodes, using data for Japan and Hong Kong. We use a random crosssectionsample split when calculating the moments of the distribution of pricechanges to mitigate the small-cross-section-sample bias noted by Cecchetti andBryan (1999). The parameter on the third moment is positive and significant inboth countries during both the inflation and deflation periods, and the parameteron the second moment changes sign in the deflation period, as the theory predicts.