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Should Central Banks Target Consumer Prices or the Exchange Rate?

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Author Info

  • Tatiana Kirsanova
  • Campbell Leith
  • Simon Wren-Lewis

Abstract

In this article we consider two arguments suggesting that monetary authorities in an open economy should target output price inflation and not consumer price inflation. The first suggests that output price inflation corresponds to the distortions caused by price rigidity. The second shows how policy rules involving consumer price inflation can induce instability because of the feedback from interest rates to consumer price inflation via the exchange rate. We examine both arguments in the context of an open economy which is subject to a range of shocks. We show that both arguments remain robust but that there is a case for including a terms of trade or real exchange rate gap term in the authorities' welfare function alongside the output gap and output price inflation. Copyright 2006 Royal Economic Society.

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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 116 (2006)
Issue (Month): 512 (06)
Pages: F208-F231
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Handle: RePEc:ecj:econjl:v:116:y:2006:i:512:p:f208-f231

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Citations

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Cited by:
  1. Cambell Leith & Simon Wren-Lewis, 2006. " The Optimal Monetary Policy Response to Exchange Rate Misalignments," CDMA Conference Paper Series 0605, Centre for Dynamic Macroeconomic Analysis.
  2. Campbell Leith & Ioana Moldovan & Raffaele Rossi, . "Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
  3. Tatiana Kirsanova & Simon Wren-Lewis, 2007. "Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," Discussion Papers 0705, Exeter University, Department of Economics.
  4. Carlos García & Jorge Restrepo & Scott Roger, 2009. "Hybrid Inflation Targeting Regimes," Working Papers Central Bank of Chile 533, Central Bank of Chile.
  5. Ozge Senay, 2007. " Interest Rate Rules and Welfare in Open Economies," CDMA Working Paper Series 0715, Centre for Dynamic Macroeconomic Analysis.
  6. Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2009. "Monetary and fiscal policy under deep habits," Working Papers 2009_32, Business School - Economics, University of Glasgow.
  7. Simon Wren-Lewis, 2011. "Comparing the delegation of monetary and fiscal policy," Economics Series Working Papers 540, University of Oxford, Department of Economics.
  8. Fernando Alexandre & Pedro Bação & John Driffill, 2007. "Optimal monetary policy with a regime-switching exchange rate in a forward-looking model," GEMF Working Papers 2007-09, GEMF - Faculdade de Economia, Universidade de Coimbra.
  9. Siok Kun, Sek, 2009. "The impacts of economic structures on the performance of simple policy rules in a small open economy," MPRA Paper 25065, University Library of Munich, Germany.
  10. Leith, Campbell & Wren-Lewis, Simon, 2009. "When is Monetary Policy All we Need?," SIRE 111, Scottish Institute for Research in Economics (SIRE).
  11. Carlin, Wendy & Soskice, David, 2010. "A New Keynesian Open Economy Model for Policy Analysis," CEPR Discussion Papers 7979, C.E.P.R. Discussion Papers.

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