Core Inflation and Monetary Policy
AbstractWhat are the implications of targeting different measures of inflation? We extend a basic theoretical framework of optimal monetary policy under inflation targeting (Svensson 1997) to include several components of CPI inflation, and analyze the implications of using different measures of inflation as the target variable--headline CPI inflation, core inflation, and CPI excluding interest rates. Our main results are the following. First, barring the interest rate component, temporary shocks to inflation do not affect optimal monetary policy under any regime. Second, indirect (second-round) effects of disturbances on target variables need to be accounted for properly. Simply excluding seemingly temporary disturbances from the reaction function risks leading to inappropriate policy responses. Third, it may be optimal to respond to changes in one measure of inflation even if the target is defined in terms of another. Fourth, the presence of the direct interest rate component in the CPI tends to push optimal monetary policy in an expansionary direction. The net effect, considering also the traditional channel, however, depends on the nature of the initial disturbance. Copyright 2001 by Blackwell Publishers Ltd.
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Bibliographic InfoArticle provided by Wiley Blackwell in its journal International Finance.
Volume (Year): 4 (2001)
Issue (Month): 3 (Winter)
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Web page: http://www.blackwellpublishing.com/journal.asp?ref=1367-0271
Other versions of this item:
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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