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.
Key Words
- Inflation
- Measurement Bias
- monetary policy
- Product Entry and Exit