Designing Indexed Units of Account

An indexed unit of account is a unit of measurement defined using an index such as a consumer price index so that prices defined in terms of these units will automatically adjust to changing economic conditions. Evidence on sticky prices and money illusion, and evidence from countries (notably Chile) that have created indexed units of account, suggests that creating such units is an important policy option for governments in countries with unstable price levels. A model is given that shows the dynamics of money prices when prices are expressed in the units. Results from the model suggest some design elements for an indexed unit of account: institutions to promote broad use of the unit for pricing, and a formal policy to increase the frequency of index computation when the price level becomes more volatile.