An Empirical Analysis of Dynamic Interrelationships Among Inflation, Inflation Uncertainty, Relative Price Dispersion, and Output Growth

Within a unified framework, the author conducts an empirical investigation of dynamic interrelationships among inflation, inflation uncertainty, relative price dispersion, and output growth. Focusing on the Canadian industrial sector, the author finds weak evidence that inflation uncertainty rises with the level of inflation, with short-run inflation uncertainty minimized at a trend inflation rate of approximately 3 per cent. With regard to the predictions of menu-cost and signal-extraction models, evidence that relative price dispersion rises with both trend inflation and inflation uncertainty is obtained. However, the significance of this evidence varies according to whether a weighted or unweighted measure of relative price dispersion is employed, in addition to the symmetry characteristics of the process governing the evolution of inflation uncertainty. The primary result is that across a variety of different model specifications, inflation uncertainty significantly lowers output growth, an effect of considerable size and duration.