Reset Price Inflation and Monetary Policy

Bils, Klenow and Malin (2009) recently constructed an empirical measure of reset price inflation (i.e. the rate of change of all "desired" prices) for the US economy, by using the micro-data underpinning the CPI and evaluated whether the existing pricing models can explain both the observed reset inflation and aggregate inflation. They found that time-dependent models and state-dependent models are both inadequate in this respect. This paper presents a model that tracks the data on reset inflation perfectly well. A main difference between the model in this paper and those in Bils et al. (2009) is that the model in this paper properly accounts for the heterogeneity in contract lengths we observe in the data.