Relative prices as aggregate supply shocks with trend inflation

David Demery and Nigel W. Duck

Ball and Mankiw (1995) use a static menu-cost model to explain the historical behaviour of the first and higher moments of commodity price changes in US producer prices. We show that when appropriately modified for a world of positive trend inflation and forward-looking behaviour 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.