Relative Prices as Aggregate Supply Shocks with Trend Inflation

Ball and Mankiw (1995) use a static menu-cost model to explain the historical behavior of the first and higher moments of commodity price changes in U.S. producer prices. We show that when appropriately modified for a world of positive trend inflation and forward-looking behavior by firms, the menu-cost model predicts a much weaker (possibly zero) correlation between the mean and the skewness of price changes than that found in the data. Copyright (c)2008 The Ohio State University.