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Cost-Push Shocks and Monetary Policy in Open Economics

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  • Alan Matthews
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    Abstract

    This paper analyses the implications of cost-push shocks for the optimal choice of monetary policy target in a two-country sticky-price model. In addition to cost-push shocks, each country is subject to labour-supply and money-demand shocks. It is shown that the fully optimal coordinated policy can be supported by independent national monetary authorities following a policy of flexible inflation targeting. A number of simple (but non-optimal) targeting rules are compared. Strict producer-price targeting is found to be the best simple rule when the variance of cost-push shocks is small. Strict consumer-price targeting is best for intermediate levels of the variance of costpush shocks . And nominal-income targeting is best when the variance of costpush shocks is high. In general, money-supply targeting and fixed nominal exchange rates are found to yield less welfare than these other regimes. Classification-

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    Bibliographic Info

    Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp034.

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    Date of creation: 20 Apr 2005
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    Handle: RePEc:iis:dispap:iiisdp034

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    Keywords: monetary policy; welfare;

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    Cited by:
    1. Pengfei Wang & Yi Wen, 2006. "Imperfect competition and sunspots," Working Papers 2006-015, Federal Reserve Bank of St. Louis.
    2. Pengfei Wang & Yi Wen, 2007. "Incomplete information and self-fulfilling prophecies," Working Papers 2007-033, Federal Reserve Bank of St. Louis.

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