What are the implications of targeting different measures of inflation? We extend a basic theoretical framework of optimal monetary policy under inflation targeting to include several components of CPI inflation ratio, and analyze the implications of using different measures of inflation as target variable — core inflation, CPI excluding interest rates, and headline CPI inflation. Our main results are the following. (i) Barring the interest rate component, temporary shocks to inflation do not affect optimal monetary policy under any regime. (ii) Indirect (second-round) effects of disturbances on goal variables need to be accounted for properly. Simply excluding seemingly temporary disturbances from the reaction function risks leading to inappropriate policy responses. (iii) It may be optimal to respond to changes in one measure of inflation even if the target is defined in terms of another. (iv) 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.
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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number
110.
Length: 35 pages Date of creation: 01 Jun 2000 Date of revision: Publication status: Published in International Finance, 2001, pages 401-439. Handle: RePEc:hhs:rbnkwp:0110
Find related papers by JEL classification: E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General 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
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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[Downloadable!]
Other versions:
Michael F. Bryan & Stephen G. Cecchetti, 1993.
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[Downloadable!] (restricted)
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[Downloadable!]
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