Intertemporal Consumption and the Measurement of Inflation: A Dynamic Inertial Price Index

This paper develops a new price index (DIPI) and discusses its characteristics and dynamics. By allowing for habit formation and inertia, our model extends typical dynamic indexes that have a forward looking component, thus providing a more effective support for the design of policy measures. We calculate the DIPI for a sample of goods for the US and prove its effectiveness in tracking business cycle, thus resulting in a more reliable indicator for the design of policy measures. Comparison with the official inflation measure matches the results of the Boskin Commission, which argues that CPI overestimates inflation.