Relative Price Variability and Nonuniform Inflationary Expectations

Abstract

Using a generalization of a rational, partial information framework presented fully in Cukierman and Wachtel (1979), it is shown that there is a positive relationship between the variance of relative price change and the variance of inflationary expectations across markets in the economy. This implication is then tested empirically using data on the variance of relative price change and on the variance of directly measured expectations. The empirical evidence supports the view that there is a positive relationship between the two variances and that more than one-third of this relationship is explainable in terms of the model presented. This paper has presented and tested a theory which indicates that changes in the variance of aggregate shocks to either demand or supply generate a positive relationship between the variance of relative price change and the (cross-sectional) variance of inflationary expectations. The simple correlations between these variances lend support to this implication. Further testing, whose purpose was to find how much of this association is explainable in terms of the hypotheses developed here, revealed that up to half of the relationship is due to measurable factors suggested by the theory. [ABSTRACT FROM AUTHOR] Copyright of Journal of Political Economy is the property of University of Chicago Press and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract. (Copyright applies to all Abstracts.)