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Relative Prices as Aggregate Supply Shocks with Trend Inflation


  • We would like to thank Jon Temple, the editor and two anonymous referees of this journal for very helpful comments on an earlier version. Remaining errors are our own.


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.