As my regular blog readers know, Paul Krugman and I often do not see eye to eye. So, once in a while, it might be useful to point out those times when we actually agree.
In a recent post on commodity prices, Paul says, “Volatile prices are volatile, which is why they shouldn’t be used to determine monetary policy.” I agree, and I suspect many other macroeconomists would as well.
I once wrote a paper on this topic with Ricardo Reis, called ”What Measure of Inflation Should a Central Bank Target?“ (published link) Here is the 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 stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.
As the graph below illustrates, the price of labor does not show any significant inflationary pressures right now:
Click on graphic to enlarge.
For more on this topic, see a recent post by MIT grad student Matt Rognlie.
