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 stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
9375.
Length: Date of creation: Dec 2002 Date of revision: Handle: RePEc:nbr:nberwo:9375
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Find related papers by JEL classification: E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
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repec:bep:maccon:v:2:y:2002:i:1:p:1009-1009 is not listed on IDEAS
Rotemberg, Julio J. & Woodford, Michael, 1999.
"The cyclical behavior of prices and costs,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 16, pages 1051-1135
Elsevier.
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