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Core Inflation and Monetary Policy

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  • Nessen, Marianne
  • Soderstrom, Ulf

Abstract

What 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 Info

Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 4 (2001)
Issue (Month): 3 (Winter)
Pages: 401-39

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Handle: RePEc:bla:intfin:v:4:y:2001:i:3:p:401-39

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  1. Stephen G. Cecchetti, 1997. "Measuring short-run inflation for central bankers," Review, Federal Reserve Bank of St. Louis, issue May, pages 143-155.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  4. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins II, 1997. "Efficient inflation estimation," Working Paper 9707, Federal Reserve Bank of Cleveland.
  5. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
  6. Danny Quah & Danny Quah & Shaun P. Vahey, 1995. "Measuring Core Inflation," CEP Discussion Papers dp0254, Centre for Economic Performance, LSE.
  7. Quah, Danny, 1995. "Measuring Core Inflation," CEPR Discussion Papers 1153, C.E.P.R. Discussion Papers.
  8. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  9. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  10. Apel, Mikael & Jansson, Per, 1999. "A Parametric Approach for Estimating Core Inflation and Interpreting the Inflation Process," Working Paper Series 80, Sveriges Riksbank (Central Bank of Sweden).
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Cited by:
  1. Gust, Christopher & Leduc, Sylvain & Sheets, Nathan, 2009. "The adjustment of global external balances: Does partial exchange-rate pass-through to trade prices matter?," Journal of International Economics, Elsevier, vol. 79(2), pages 173-185, November.
  2. Jamie Armour, 2006. "An Evaluation of Core Inflation Measures," Working Papers 06-10, Bank of Canada.
  3. Jeffery D. Amato & Andrew Filardo & Gabriele Galati & Goetz von Peter & Feng Zhu, 2005. "Research on exchange rates and monetary policy: an overview," BIS Working Papers 178, Bank for International Settlements.
  4. Berg, Claes & Jansson, Per & Vredin, Anders, 2004. "How Useful are Simple Rules for Monetary Policy? The Swedish Experience," Working Paper Series 169, Sveriges Riksbank (Central Bank of Sweden).
  5. Michael Krause & Wolfgang Lemke, 2006. "Optimal Monetary Policy Response to Distortionary Tax Changes," Computing in Economics and Finance 2006 306, Society for Computational Economics.
  6. Virginie Traclet, 2004. "Monetary and Fiscal Policies in Canada: Some Interesting Principles for EMU?," Working Papers 04-28, Bank of Canada.
  7. Dillén, Hans, 2002. "Inflation Targeting and the Dynamics of the Transmission Mechanism," Working Paper Series 141, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jul 2004.

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