The Effect of Inflation on Relative Price Variability in Iran

Firms tend to base production decision on relative price (real) of their products. One of the introduced and known costs of inflation in macroeconomic literature is that, inflation can create fluctuations in the relative prices of products and goods. In this way, this could lead to misallocation of scarce economic resources. Therefore, one of the ways and method in which inflation rate is looked at is to focus on minimizing relative prices variability of products. Empirical research in this area suggests that the relationship between inflation and relative prices variability (RPV) could be linear or u-shaped quadratic. Using the ordinary least squares (OLS) method, this study investigates the relationship between inflation and relative price variability based on monthly time series data form Iran during 2002 - 2014. The results of this study show that there is a nonlinear and quadratic (U- shaped) relation between inflation and relative price variability. The results also show that minimizing relative prices variability rate of inflation is al-most 21 percent. Finally results from generalized Auto-Regressive Conditional Heteroscedasticity model (GARCH) used in this study show and indicate both positive unexpected inflation and negative unexpected inflation have a symmetric and regular effect on the rela-tive price variability.