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

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  • Giancarlo Corsetti
  • Luca Dedola
  • Sylvain Leduc

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 favor 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13544.

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Date of creation: Oct 2007
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Publication status: published as Giancarlo Corsetti, Luca Dedola, Sylvain Leduc. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," in Jordi Gali and Mark J. Gertler, editors, "International Dimensions of Monetary Policy " University of Chicago Press (2009)
Handle: RePEc:nbr:nberwo:13544

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Citations

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Cited by:
  1. Bussière, Matthieu & Peltonen, Tuomas A., 2008. "Exchange rate pass-through in the global economy: the role of emerging market economies," Working Paper Series 0951, European Central Bank.
  2. Ehsan U. Choudhri & Dalia Hakura, 2012. "The Exchange Rate Pass -Through to Import and Export Prices: The Role of Nominal Rigidities and Currency Choice," IMF Working Papers 12/226, International Monetary Fund.
  3. Riccardo DiCecio & Edward Nelson, 2009. "Euro Membership as a U.K. Monetary Policy Option: Results from a Structural Model," NBER Working Papers 14894, National Bureau of Economic Research, Inc.
  4. Jimborean, R., 2011. "The Exchange Rate Pass-Through in the New EU Member States," Working papers 341, Banque de France.
  5. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  6. Giancarlo Corsetti, 2008. "A Modern Reconsideration of the Theory of Optimal Currency Areas," Economics Working Papers ECO2008/12, European University Institute.

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