Product Replacement Bias in Inflation and its Consequences for Monetary Policy
Title: Product Replacement Bias in Inflation and its Consequences for Monetary Policy
Author: WEBER, Henning
Citation: Journal of Money, Credit and Banking, 2012, 44, 2-3, 255–299
ISSN: 1538-4616; 0022-2879
The paper examines a New Keynesian model with product entry and exit and with two types of households. Households consume different product baskets, and therefore, face different inflation rates. The statistical bureau used in the model measures aggregate inflation, but observes product entry with a probabilistic delay. Consequently, measured inflation suffers from product replacement bias with respect to aggregate inflation. Measured inflation is less volatile but more persistent than aggregate inflation, and the correlation between aggregate inflation and aggregate output is lower than the correlation between measured inflation and measured output. When monetary policy responds to measured variables, it stabilizes aggregate inflation insufficiently. Nevertheless, under discretionary monetary policy, responding to measured variables improves welfare.
Article first published online: 27 MAR 2012; The article is a revised version of EUI Working Paper, RSCAS 2009/44
Type of Access: openAccess