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Journal of Monetary Economics - Columbia University

On quality bias and inflation targetsStephanie Schmitt-Grohe a,b,c, Mart n Uribea,b,naDepartment of Economics , Columbia University , 420 West 118th Street MC3308, NY 10027, United StatesbNBER, United StatescCEPR, United Kingdomarticle infoArticle history:Received 5 November 2009 Received in revised form21 February 2012 Accepted 21 February 2012 Available online 1 April 2012abstractDoes Ramsey optimal policy call for adjusting the inflation target by the size of thequality bias in measured inflation? We find that if it is nonhedonic (or sticker) pricesthat are sticky, the conventional view, according to which it is optimal to adjust theinflation target upward by the size of the quality bias, is misguided.

The household cares about a composite good, a t, given by at ¼ Z 1 0 ðx itc Þ 1 1=Z di 1=ð1 1=ZÞ, ð2Þ where Z41 denotes the elasticity of substitution across different good varieties.Note that the utility of the household increases with the quality content of each good.

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