Discussion or working paper
Monetary policy and mismeasured inflation
AbstractI examine the standard New Keynesian model augmented with product entry and exit. The statistical agency in the model measures product entry with a delay. Consequently, measured inflation departs from true, utility-based inflation. I show that the gap between measured inflation and true inflation is serially correlated and varies with the state of the economy. This result contrasts with the common assumption of white-noise exogenous measurement error. True inflation is more volatile and less persistent than measured inflation, and the correlation between true inflation and true output is lower than the correlation between measured inflation and measured output. Furthermore, I analyze monetary policy given the measurement problem.
KeywordsMeasurement Bias, Inflation, Monetary Policy, Product Entry and Exit
JEL classificationE01, E31, E32