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Optimal Monetary Policy and the Sources of Local-Currency Price Stability

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  • Corsetti, Giancarlo
  • Dedola, Luca
  • Leduc, Sylvain

Abstract

We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favour of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6557.

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Date of creation: Nov 2007
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Handle: RePEc:cpr:ceprdp:6557

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Keywords: exchange rate pass-through; optimal monetary policy; price discrimination; price dispersion; real exchange rates;

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Citations

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Cited by:
  1. Riccardo DiCecio & Edward Nelson, 2009. "Euro membership as a U.K. monetary policy option: results from a structural model," Working Papers 2009-012, Federal Reserve Bank of St. Louis.
  2. Bussière, Matthieu & Peltonen, Tuomas, 2008. "Exchange rate pass-through in the global economy – the role of emerging market economies," BOFIT Discussion Papers 25/2008, Bank of Finland, Institute for Economies in Transition.
  3. Jimborean, R., 2011. "The Exchange Rate Pass-Through in the New EU Member States," Working papers 341, Banque de France.
  4. Ehsan U. Choudhri & Dalia Hakura, 2012. "The Exchange Rate Pass -Through to Import and Export Prices," IMF Working Papers 12/226, International Monetary Fund.
  5. Giancarlo Corsetti, 2008. "A Modern Reconsideration of the Theory of Optimal Currency Areas," European Economy - Economic Papers 308, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  6. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.

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