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What Should Inflation Targeting Countries Do When Oil Prices Rise and Drop Fast?

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Author Info

  • Nicoletta Batini
  • Eugen Tereanu

Abstract

After a long period of global price stability, in 2008 inflation increased sharply following unprecedented increases in the price of oil and other commodities, notably food. Although inflation remained lower and growth higher in inflation targeting countries than elsewhere, almost everywhere price stability seemed in jeopardy as consumer prices kept surging and central banks struggled to maintain expectations anchored. The rapid drop in energy and food prices that later accompanied the world slowdown helped avert the worse, but inflation stayed high in many inflation targeting countries. This paper uses a small open-economy DSGE model to design the correct monetary policy response to a protracted supply shock of the kind observed today, and explains how to choose optimal policy horizons under such shock. Using a version of the model with Kalman learning, the paper also evaluates the implications of a loss of target credibility, showing how rules must be adjusted when the authorities'' commitment to low inflation has been eroded. The appropriate response to future evolutions of the price of oil, including to a large downward correction as recently observed, is also evaluated.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/101.

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Length: 32
Date of creation: 01 May 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/101

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Related research

Keywords: Inflation targeting; Oil prices; Agricultural commodities; Agricultural prices; Commodity price fluctuations; Consumer prices; Economic models; External shocks; Price stabilization; inflation; monetary policy; central bank; monetary economics; monetary policy rules; inflation target; nominal interest rate; optimal monetary policy; low inflation; monetary fund; inflationary pressures; inflation response; real rates; monetary policy rule; price stability; real interest rate; real output; monetary authorities; gdp deflator; percent inflation; inflation dynamics; inflation-targeting; monetary authority; inflation rates; actual inflation; inflation rate; monetary transmission; inflationary pressure; monetary policies; rational expectations; rate of inflation; real interest rates;

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References

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Citations

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Cited by:
  1. Rigoberto Ariel Yépez-Garcia & Julie Dana, 2012. "Mitigating Vulnerability to High and Volatile Oil Prices : Power Sector Experience in Latin America and the Caribbean," World Bank Publications, The World Bank, number 9341, October.
  2. Marc Pourroy & Benjamin Carton & Dramane Coulibaly, 2012. "Food Prices and Inflation Targeting in Emerging Economies," Working Papers 2012-33, CEPII research center.
  3. Seedwell Hove & Albert Touna Mama & Fulbert Tchana Tchana, 2012. "Terms of Trade Shocks and Inflation Targeting in Emerging Market Economies," Working Papers 273, Economic Research Southern Africa.

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