Working Paper: NBER ID: w15505
Authors: Stephanie Schmitt-Grohe; Martin Uribe
Abstract: A policy issue central banks are confronted with is whether inflation targets should be adjusted to account for the systematic upward bias in measured inflation due to quality improvements in consumption goods. We show that in the context of a Ramsey equilibrium 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 Ramsey plan predicts that the inflation target should not be corrected. If, on the other hand, quality-adjusted (or hedonic) prices are assumed to be sticky, then the Ramsey plan calls for raising the inflation target by the magnitude of the bias.
Keywords: Quality Bias; Inflation Targets; Ramsey Optimal Policy
JEL Codes: E52; E6
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 remain unchanged (E31) |
| Quality-adjusted prices are sticky (E31) | Inflation target should be raised by the magnitude of the quality bias (E31) |
| Quality bias present (C83) | Optimal inflation target should be adjusted upwards (E31) |