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Sticky Wages, Incomplete Pass-Through and Inflation Targeting: What is the Right Index to Target?

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  • Abo-Zaid, Salem

Abstract

This paper studies optimal monetary policy in a small open economy with Inflation Targeting, incomplete pass-through and rigid nominal wages. The paper shows that the right index to target depends on the structure of the individual economy. When wages are fully flexible, the consumer price index (CPI) is better to target given low to moderate levels of pass-through. On the other hand, assuming complete pass-through, economies with relatively high degrees of wage rigidity and wage indexation should either target their CPIs or fully stabilize nominal wages. Also, CPI targeting and nominal wage targeting are superior to targeting the Producer Price Index (DPI) in relatively high degrees of pass-through given that wages are relatively rigid and indexation degrees are high. The results of the paper suggest that, by committing to a common monetary policy in a common-currency area, some countries may not be conducting monetary policy optimally.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13177.

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Date of creation: 05 Feb 2009
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Handle: RePEc:pra:mprapa:13177

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Keywords: Optimal Monetary Policy; Incomplete Pass-Through; Sticky Wages; Inflation Targeting; Conumer Price Index; Domestic Price Index;

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References

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  1. Devereux, Michael B & Lane, Philip R., 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEPR Discussion Papers 2874, C.E.P.R. Discussion Papers.
  2. José M. Campa & Linda S. Goldberg & José M. González-Mínguez, 2005. "Exchange rate pass through to import prices in the euro area," Banco de Espa�a Working Papers 0538, Banco de Espa�a.
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  7. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  8. Olivier Blanchard & Jordi Galí, 2005. "Real wage rigidities and the new Keynesian model," Economics Working Papers 912, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2005.
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  13. A. Campolmi, 2005. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Working Papers 553, Dipartimento Scienze Economiche, Universita' di Bologna.
  14. Alessandro Flamini, 2004. "Inflation Targeting and Exchange Rate Pass-Through," IHEID Working Papers 04-2004, Economics Section, The Graduate Institute of International Studies.
  15. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
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  17. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
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Cited by:
  1. Kancs, d'Artis & Kielyte, Julda, 2010. "European Integration and Labour Migration," European Integration online Papers (EIoP), European Community Studies Association Austria (ECSA-A), vol. 14, November.
  2. d'Artis Kancs & Pavel Ciaian, 2007. "Blue Cards, Blue Prospects?," LICOS Discussion Papers 19407, LICOS - Centre for Institutions and Economic Performance, KU Leuven.
  3. Pavel Ciaian & d'Artis Kancs & Jan Pokrivcak, 2008. "Comparative Advantages, Transaction Costs and Factor Content of Agricultural Trade: Empirical Evidence from the CEE," EERI Research Paper Series EERI_RP_2008_03, Economics and Econometrics Research Institute (EERI), Brussels.
  4. Ciaian, Pavel & Kancs, d'Artis, 2011. "Food, energy and environment: Is bioenergy the missing link?," Food Policy, Elsevier, vol. 36(5), pages 571-580, October.
  5. James Anderson, 2001. "Migration, FDI, and the Margins of Trade," EERI Research Paper Series EERI_RP_2001_05, Economics and Econometrics Research Institute (EERI), Brussels.

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