DP7550 On Quality Bias and Inflation Targets

Author(s): Stephanie Schmitt-Grohé, Martín Uribe
Publication Date: November 2009
Keyword(s): Inflation Targets, Quality Bias, Ramsey Policy
JEL(s): E52, E6
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7550

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.