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We propose a new methodology to construct core inflation which is, unlike other conventional methods, not based on ad hoc elimination/trimming of prices. The empirical results suggest that the proposed measure of core inflation is highly correlated with headline inflation and is noise free; hence less volatile. The underlying inflation derived from such method is found to be a powerful leading indicator of headline inflation while other conventional measures do not seem to reflect such fundamental property of core inflation.

This study examines whether skewness of the cross-sectional distribution of relative price changes is positively associated with aggregate inflation as predicted by the menu cost model of Ball and Mankiw (1994, 1995). Further, the study examines the size and frequency of price changes across various commodities and the distribution of relative price changes. The results from highly disaggregated Indian wholesale price index (WPI) data suggest that the skewness of relative price changes explains a significant proportion of short-run fluctuations in aggregate inflation. More importantly, the results indicate that the average size of price increases is greater than the size of price decreases implying downwards rigidity in the prices of various commodities. JEL Classification: E30, E31, E52

We construct an error correction mechanism to examine whether firms' price adjustment is asymmetric as anticipated by . We have used monthly time series data on prices of 418 commodities, which constitute 97 percent of commodity price basket used in the construction of wholesale price index in India. The empirical evidence indicates that the price adjustment of most of the firms exhibits strong asymmetry; shocks that increases firms' desired prices causes quicker and larger rise in prices whereas shocks that lower desired prices causes smaller or no fall in prices. Also, we identify a threshold value for each firm below which it does not allow its relative price to fall. These evidences imply that larger relative price variability can trigger inflation even in the absence of demand shocks. Moreover, the distribution of output is likely to be negatively skewed even if the demand shocks are symmetric.