Abstract
We investigate the relationship between inflation and price variation using highly disaggregated, weekly price data for consumption goods recorded in Germany during 1995, a low‐inflation period. We find a significant positive correlation between the rates of price change and price dispersion, both at the level of individual products and product groups. However, we find no correlation between the rates of price change and price variability. Together with results from similar studies, Tommasi (1993. Optimal Pricing, Inflation, and the Cost of Price Adjustment. MIT Press: London, Cambridge, MA; 485–511) and Parsley (1996. J. Money Credit Banking 28: 323–341), a remarkable pattern emerges: when aggregate nominal shocks are small, only price dispersion is correlated with price changes. As the rate of inflation rises, both variability and dispersion become affected. During hyper‐inflation, systematic movements of price dispersion seem to disappear. We conclude that price dispersion is best explained by micro‐economic frictions in price adjustment, whereas price variability appears to be related to costly price search and information problems. Copyright © 2007 John Wiley & Sons, Ltd.