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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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Cited by:
  1. Bussière, Matthieu & Peltonen, Tuomas, 2008. "Exchange rate pass-through in the global economy – the role of emerging market economies," BOFIT Discussion Papers 25/2008, Bank of Finland, Institute for Economies in Transition.
  2. Giancarlo Corsetti, 2008. "A Modern Reconsideration of the Theory of Optimal Currency Areas," European Economy - Economic Papers 308, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  3. Jimborean, R., 2011. "The Exchange Rate Pass-Through in the New EU Member States," Working papers 341, Banque de France.
  4. Riccardo DiCecio & Edward Nelson, 2009. "Euro membership as a U.K. monetary policy option: results from a structural model," Working Papers 2009-012, Federal Reserve Bank of St. Louis.
  5. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
  6. Philippe Jeanfils, 2008. "Imperfect exchange rate pass-through : the role of distribution services and variable demand elasticity," Working Paper Research 135, National Bank of Belgium.
  7. 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.

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