Working Paper: CEPR ID: DP7550
Authors: Stephanie Schmittgroh; MartÃn Uribe
Abstract: This paper studies whether the central bank should adjust its inflation target to account for the systematic upward bias in measured inflation due to quality improvements in consumption goods. We show that the answer to this question depends on what prices are assumed to be sticky. If nonquality-adjusted prices are assumed to be sticky, then the inflation target should not be corrected. If, on the other hand, quality-adjusted (or hedonic) prices are assumed to be sticky, then the inflation target should be raised by the magnitude of the bias.
Keywords: inflation targets; quality bias; Ramsey policy
JEL Codes: E52; E60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Non-quality-adjusted prices are sticky (C54) | Inflation target should not be adjusted for quality bias (E31) |
| Quality-adjusted prices are sticky (E31) | Inflation target should be adjusted upwards by the magnitude of the quality bias (E31) |
| Quality-adjusted prices are sticky (E31) | Optimal inflation target aligns with the rate of quality improvement (E31) |