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A Dynamic Measure of Inflation

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Ricardo Reis

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Abstract

This paper shows that conventional measures of cost-of-living inflation, based on static models of consumption, suffer from two problems. The first is an intertemporal substitution bias, as these measures neglect the ability of consumers to borrow and lend in response to price changes. The second problem is the omission of intertemporal prices, which capture relevant relative prices for a consumer who lives for many periods. The paper proposes a dynamic price index (DPI) that solves these problems. Theoretically, it shows that the DPI is forward-looking, responds by more to persistent shocks, includes assets prices, and distinguishes between durable and non-durable goods' prices. A constructed DPI for the United States from 1970 to 2008 differs markedly from the CPI, it is close to serially uncorrelated, it is mostly driven by the prices of houses and bonds, and is twice as high as the CPI in 2008.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11746.

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Date of creation: Nov 2005
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Handle: RePEc:nbr:nberwo:11746

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Michael Parkin, 2009. "What is the Ideal Monetary Policy Regime? Improving the Bank of Canada's Inflation-targeting Program," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 279, January. [Downloadable!]
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