Asymmetric Impact of Relative Price Shocks in Presence of Trend Inflation

This study examines whether skewness of cross sectional distribution of relative price shocks has asymmetric impact on aggregate inflation. The empirical evidence from various countries suggests that the positively skewed shocks have different impact from that of negatively skewed shocks on aggregate inflation. Consistent with the predictions of menu cost models, the empirical results indicate that this asymmetry in the impact of relative price shocks mainly depends on the nature of trend that inflation exhibits for a given period. The crucial inference that emerges from the empirical findings is that the traditional approach of using a linear regression model, to examine the relationship between inflation and skewness during the period with trend inflation, is not appropriate as it may result in misspecification and misleading conclusions. [MSE Working paper No. 153].