Monetary Policy and Mismeasured Inflation

Abstract

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 in ation departs from true, utility-based in ation. I show that the gap between measured in ation and true in ation 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 in ation is more volatile and less persistent than measured in ation, and the correlation between true in ation and true output is lower than the correlation between measured in ation and measured output. Furthermore, I analyze monetary policy given the measurement problem.