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Monetary Policy in Open Economies: Price Inertia and Inflation Targeting

Author

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  • Rigon, Massimiliano

    (University of Glasgow)

Abstract

In this paper we consider a two-country model. Each country is characterised by several different sources of nominal inertia. This distinguishes our model from others in the so called New Open Economy Macroeconomics and makes it a suitable framework within which analyse the stabilising properties of monetary policies. We show that the variance of inflation induced by domestic inflationary shocks is lower under CPI targeting than when we target a measure of output price inflation. In fact, market segmentation and staggered wage and price setting result in lower and more persistent foreign inflation responses to a domestic inflationary shocks. This inertia in foreign price adjustments is completely passed through into CPI inflation but not into output price inflation. These differences cannot be detected in traditional models that usually introduce sluggish adjustments of domestic output prices as the only source of inertia. Furthermore, we find a limited role for the exchange rate in affecting the stabilising properties of the rules.

Suggested Citation

  • Rigon, Massimiliano, 2003. "Monetary Policy in Open Economies: Price Inertia and Inflation Targeting," Royal Economic Society Annual Conference 2003 173, Royal Economic Society.
    • Handle: RePEc:ecj:ac2003:173
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    More about this item

    Keywords

    monetary policy; inflation targeting; open economy; exchange rate; staggered price;
    All these keywords.

    JEL classification:

    • 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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