Inflation Skewness and Price Indexation

Peyman Firouzi Naeim and Golnoush Rahimzadeh

MPRA Paper from University Library of Munich, Germany

Abstract: One of the two price indexation schemes in the staggered price DSGE models is the indexation to the average inflation. In this essay we show that using average of inflation as index multiplier may lead to the deviation from the optimal price for intermediate good producer. Although there is no problem with this indexation method as far as the inflation distribution is symmetric, when we have a skewed inflation (as we have in the U.S. economy and most of the G7 countries) indexation to average inflation does not reflect the profit maximizer firm's decision making process. After showing the deficiencies of this method we introduce the Median of inflation distribution as a measure, explain it's advantage and support our claim by comparing the simulated inflation and the measure which is used for indexation purpose. Our results suggest that median of inflation distribution minimizes the forecast error in the Calvo price setting procedure of intermediate good producer

Keywords: DSGE; Inflation Skewness; Non-Linearity; Calvo Pricing (search for similar items in EconPapers)
JEL-codes: E30 E31 E37 E50 E52 (search for similar items in EconPapers)
Date: 2013-04
New Economics Papers: this item is included in nep-mac and nep-mon
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https://mpra.ub.uni-muenchen.de/52335/22/MPRA_paper_52335.pdf revised version (application/pdf)

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