A PanelSmooth Transition Approach to Inflation and Relative Price Variability in China

This paper examines the relationship between inflation and relative price variability (RPV) by using provincial level data from China. The data contains three different inflation regimes and evidence of smooth transition is statistically prominent and the province-specific time-varying marginal impact of inflation on RPV varies substantially across inflation regimes. The inflation-RPV linkage is stronger when inflation is moderately high, but tends to fade out and might eventually disappear when inflation is steadily low. The policy implication of this result is that inflation targets should be set within a range in which the inflation-RPV link is the weakest (i.e. low-inflation regime) to minimize undesirable price dispersion induced by inflation.