Working Paper: NBER ID: w9375
Authors: N. Gregory Mankiw; Ricardo Reis
Abstract: This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector's characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.
Keywords: No keywords provided
JEL Codes: E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| choice of inflation measure (E31) | economic stability (E63) |
| weight of nominal wages in price index (J31) | economic stability (E63) |
| sector characteristics (L80) | weight of sectors in stability price index (C43) |
| sector characteristics (L80) | economic stability (E63) |
| appropriate targeting of inflation measures (E31) | economic stability (E63) |