Understanding Inflation: Implications for Monetary Policy

If prices and wages were perfectly flexible, monetary policy would be irrelevant. But casual observation suggests both that nominal prices and wages are at least somewhat rigid and that monetary policy has real effects. Economists’ understanding of the nature of these rigidities has improved in recent years. At the same time, policy makers have begun to incorporate economists’ theoretical and empirical findings in their institutions and actions. This chapter explores the ways in which our empirical understanding of nominal rigidities informs three key dimensions of the conduct of monetary policy: how we measure core inflation, how we control inflation, and how we choose inflation targets.