American Economic Review: Insights
ISSN 2640-205X (Print) | ISSN 2640-2068 (Online)
Substitution Bias and Fixed-Weight Price Indices in Time-Dependent Pricing Models
American Economic Review: Insights
(pp. 109–23)
Abstract
This paper compares measured inflation in true and fixed-weight price indices. We construct model-based inflation measures in time-dependent pricing models that are analogous to measures of inflation in the data—for example, the consumer price index. In the standard new Keynesian model, when inflation rises rapidly, the differences between inflation in those indices and true price indices are increasing in the degree of price stickiness and the elasticity of substitution across goods. For commonly used parameter values, those differences are large and persistent for increases in inflation of the size seen after 2020 in the United States.Citation
Christiano, Lawrence J., Martin Eichenbaum, and Benjamin K. Johannsen. 2026. "Substitution Bias and Fixed-Weight Price Indices in Time-Dependent Pricing Models." American Economic Review: Insights 8 (1): 109–23. DOI: 10.1257/aeri.20240660Additional Materials
JEL Classification
- E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
- E31 Price Level; Inflation; Deflation