RELATIVE PRICE VARIABILITY AND INFLATION IN AN EQUILIBRIUM PRICE MISPERCEPTIONS MODEL - EVIDENCE FOR THE UK

In this paper we investigate the relationship between relative price variability and inflation in the United Kingdom using the equilibrium price misperceptions' mode of Lucas (American Economic Review, 1973, 63, 526-534). We obtain a data consistent version of the equilibrium price misperceptions' model linking relative price variability, inflation and a small set of key macroeconomic variables. We find a significant, positive role for inflation in explaining relative price variability and suggest that this may be due to a positive relation between the variance of sector-specific shocks and inflation.