TY  - JOUR
AU  - Reis,Ricardo
AU  - Watson,Mark W.
TI  - Relative Goods' Prices and Pure Inflation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13615
PY  - 2007
Y2  - November 2007
UR  - http://www.nber.org/papers/w13615
L1  - http://www.nber.org/papers/w13615.pdf
N1  - Author contact info:
Ricardo Reis
Department of Economics, MC 3308
Columbia University
420 West 118th Street, Rm. 1022 IAB
New York  NY  10027
Tel: 609/258-8531
Fax: 609/258-5196
E-Mail: rreis@columbia.edu

Mark W. Watson
Department of Economics
Princeton University
Princeton, NJ 08544-1013
Tel: 609/258-4811
Fax: 609/258-5533
E-Mail: mwatson@princeton.edu
AB  - This paper uses a dynamic factor model for the quarterly changes in consumption goods' prices to separate them into three components: idiosyncratic relative-price changes, aggregate relative-price changes, and changes in the unit of account.  The model identifies a measure of "pure" inflation: the common component in goods' inflation rates that has an equiproportional effect on all prices and is uncorrelated with relative price changes at all dates.  The estimates of pure inflation and of the aggregate relative-price components allow us to re-examine three classic macro-correlations.  First, we find that pure inflation accounts for 15-20% of the variability in overall inflation, so that most changes in inflation are associated with changes in goods' relative prices.  Second, we find that the Phillips correlation between inflation and measures of real activity essentially disappears once we control for goods' relative-price changes.  Third, we find that, at business-cycle frequencies, the correlation between inflation and money is close to zero, while the correlation with nominal interest rates is around 0.5, confirming previous findings on the link between monetary policy and inflation.
ER  -