Working Paper

Monetary policy and mismeasured inflation

I 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.


Henning Weber


Publication Date
JEL Classification
E01, E31, E32