Kiel Working Papers, Kiel Institute for World Economics
No 1364:
Measuring changes in the value of the numeraire
Ricardo Reis and Mark W. Watson
Abstract: This paper estimates a common component in many price
series that has an equiproportional effect on all prices. Changes in this
component can be interpreted as changes in the value of the numeraire
since, by definition, they leave all relative prices unchanged. The first
aim of the paper is to measure these changes. The paper provides a
framework for identifying this component, suggests an estimator for the
component based on a dynamic factor model, and assesses its performance
relative to alternative estimators. Using 187 U.S. time-series on prices,
we estimate changes in the value of the numeraire from 1960 to 2006, and
further decompose these changes into a part that is related to relative
price movements and a residual ‘exogenous’ part. The second aim of the
paper is to use these estimates to investigate two economic questions.
First, we show that the size of exogenous changes in the value of the
numeraire helps distinguish between different theories of pricing, and that
the U.S. evidence argues against several strict theories of nominal
rigidities. Second, we find that changes in the value of the numeraire are
significantly related to changes in real quantities, and discuss
interpretations of this apparent non-neutrality.
Keywords: Inflation, Money illusion, Monetary neutrality, Price index; (follow links to similar papers)
JEL-Codes: E31,; C43,; C32; (follow links to similar papers)
57 pages, June 2007
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