Nonlinear Impact of Inflation on Relative Price Variability

In this paper we investigate the link between inflation and relative price variability, and the impact of structural changes in the behavior of inflation using a half-a-century long disaggregated data. Employing panel data techniques to control for aggregate shocks, we show that: 1) the effect of inflation is non-neutral: relative price variability has increased in inflationary as well as deflationary periods, 2) the association between inflation and relative price variability is highly nonlinear 3) there is strong support for menu cost models, but none for signal extraction models.