What Measure of Inflation Should a Central Bank Target?

40 Pages Posted: 12 Nov 2002

See all articles by N. Gregory Mankiw

N. Gregory Mankiw

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Ricardo Reis

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2002

Abstract

This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector's characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum economic stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.

Keywords: Inflation targeting, monetary policy

JEL Classification: E42, E52, E58

Suggested Citation

Mankiw, N. Gregory and Reis, Ricardo A.M.R., What Measure of Inflation Should a Central Bank Target? (November 2002). ECB Working Paper No. 170; Harvard Institute Research Working Paper No. 1984. Available at SSRN: https://ssrn.com/abstract=348082

N. Gregory Mankiw (Contact Author)

Harvard University - Department of Economics ( email )

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Ricardo A.M.R. Reis

London School of Economics & Political Science (LSE) ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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