The Central Bank of the Republic of Turkey

Relative price variability leads to inefficiencies in the allocation of resources that reduce real income (Fischer, 1981). Given the costs associated with relative price variability, the relation between inflation and relative price variability has been extensively researched and a positive relation between the two is documented for many countries and for varying time periods. Investigating the relative price variability is not only important for understanding the costs of inflation but also for understanding the inflationary dynamics given the fact that one of the main sources of relative price variability is differential speeds of price adjustment in different sub-sectors. In this paper, highly disaggregated data based on 103 classification of Turkish CPI for the period between January 1994 and December 2002 is utilized. The statistical findings based on Theil (1967) measure of relative price variability, are analyzed from different perspectives: seasonal pattern, time aggregation, different sub-groups, e.g. tradable/non-tradable prices, administered/non-administered prices etc. Resulting facts are discussed within the recent developments in the Turkish economy. The relation between relative price variability and inflation is verified by carrying out model-free regressions. The results show that there is a positive contemporaneous association between relative price variability and inflation in Turkey. Besides, inflation is found to Granger-cause relative price variability. These conclusions are shown to be robust to the degree of commodity aggregation. Topics in Middle Eastern and African Economies Vol. 6, September 2004