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Sticky Wages, Incomplete Pass-Through and Inflation Targeting: What is the Right Index to Target?

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  • Salem M. Abo-Zaid

Abstract

This paper studies strict monetary policy rules in a small open economy with Inflation Targeting, incomplete pass-through and rigid nominal wages. The paper shows that, when nominal wages are fully flexible and pass-through is low to moderate, the monetary authority should target the Consumer Price Index (CPI) rather than the Domestic Price Index (DPI). When pass-through is high, an economy with high degrees of nominal wage rigidity and wage indexation should either target the CPI or fully stabilise nominal wages. These results suggest that, by committing to a common monetary policy in a common-currency area, some countries may not be following the right monetary policy rules.

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File URL: http://www.eeri.eu/documents/jee/JEE_2010_01_02.pdf
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Bibliographic Info

Article provided by Economics and Econometrics Research Institute (EERI), Brussels in its journal Journal of Economics and Econometrics.

Volume (Year): 53 (2010)
Issue (Month): 1 ()
Pages: 28-58

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Handle: RePEc:eei:journl:v:53:y:2010:i:1:p:28-58

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Keywords: Monetary policy rules; Inflation targeting ; Exchange rate pass-through; Nominal wage rigidity; Open economy.;

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References

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  1. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  2. José M. Campa & Linda S. Goldberg & José M. González-Mínguez, 2005. "Exchange rate pass through to import prices in the euro area," Banco de Espa�a Working Papers 0538, Banco de Espa�a.
  3. Olivier J. Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  6. Devereux, Michael B & Lane, Philip R., 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEPR Discussion Papers 2874, C.E.P.R. Discussion Papers.
  7. Vincent Bodart & Gregory de Walque & Olivier Pierrard & Henri R. Sneessens & Raf Wouters, 2006. "Nominal wage rigidities in a new Keynesian model with frictional unemployment," Working Paper Research 97, National Bank of Belgium.
  8. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  9. Mark Gertler & Lars Svensson & Andrea Ferrero, 2008. "Current Account Dynamics and Monetary Policy," 2008 Meeting Papers 359, Society for Economic Dynamics.
  10. Böckerman, Petri & Laaksonen, Seppo & Vainiomäki, Jari, 2006. "Micro-level evidence on wage rigidities in Finland," MPRA Paper 1811, University Library of Munich, Germany.
  11. Alessia Campolmi, 2006. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Economics Working Papers 961, Department of Economics and Business, Universitat Pompeu Fabra.
  12. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers.
  13. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  14. Campa, José Manuel & Goldberg, Linda S, 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  16. Flamini, Alessandro, 2007. "Inflation targeting and exchange rate pass-through," Journal of International Money and Finance, Elsevier, vol. 26(7), pages 1113-1150, November.
  17. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  18. Huang, Kevin X. D. & Liu, Zheng, 2002. "Staggered price-setting, staggered wage-setting, and business cycle persistence," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 405-433, March.
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Cited by:
  1. Ciaian, Pavel & Kancs, d'Artis, 2011. "Food, energy and environment: Is bioenergy the missing link?," Food Policy, Elsevier, vol. 36(5), pages 571-580, October.
  2. Kancs, d'Artis & Kielyte, Julda, 2010. "European Integration and Labour Migration," European Integration online Papers (EIoP), European Community Studies Association Austria (ECSA-A), vol. 14, November.
  3. Ciaian, Pavel & Kancs, d'Artis & Pokrivcak, Jan, 2011. "Comparative Advantages, Transaction Costs and Factor Content in Agricultural Trade: Empirical Evidence from the CEE - Vantaggi comparati, costi di transazione e contenuto dei fattori nel commercio agr," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 64(1), pages 67-101.
  4. James Anderson, 2001. "Migration, FDI, and the Margins of Trade," EERI Research Paper Series EERI_RP_2001_05, Economics and Econometrics Research Institute (EERI), Brussels.
  5. d'Artis Kancs & Pavel Ciaian, 2007. "Blue Cards, Blue Prospects?," LICOS Discussion Papers 19407, LICOS - Centre for Institutions and Economic Performance, KU Leuven.

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