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What Measure of Inflation Should a Central Bank Target?

Author

Listed:
  • N. Gregory Mankiw
  • Ricardo Reis

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 microeconimic 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.

Suggested Citation

  • N. Gregory Mankiw & Ricardo Reis, 2002. "What Measure of Inflation Should a Central Bank Target?," Harvard Institute of Economic Research Working Papers 1984, Harvard - Institute of Economic Research.
    • Handle: RePEc:fth:harver:1984
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    File URL: http://www.economics.harvard.edu/pub/hier/2002/HIER1984.pdf
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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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