Inflation and the Dispersion of Component Price Indices: A Case for Four Percent Solution

Unlike earlier literature that documented positive association between inflation and the dispersion of relative prices over time, the empirical evidence from this study suggests that the relative price dispersion increases in response to the deviation of inflation from certain threshold/target level in either direction rather than the inflation per se. More importantly, the inflation rate at which the dispersion of relative prices is minimized turn out to be 4 percent for US and Japan; hence, supporting the proposal of 4 percent inflation target for both the countries.