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Core Inflation and Monetary Policy

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  • Marianne Nessén
  • Ulf Söderström

Abstract

What are the implications of targeting different measures of inflation? We extend a basic theoretical framework of optimal monetary policy under inflation targeting (Svensson 1997) to include several components of CPI inflation, and analyse the implications of using different measures of inflation as the target variable – headline CPI inflation, core inflation, and CPI excluding interest rates. Our main results are the following. First, barring the interest rate component, temporary shocks to inflation do not affect optimal monetary policy under any regime. Second, indirect (second‐round) effects of disturbances on target variables need to be accounted for properly. Simply excluding seemingly temporary disturbances from the reaction function risks leading to inappropriate policy responses. Third, it may be optimal to respond to changes in one measure of inflation even if the target is defined in terms of another. Fourth, the presence of the direct interest rate component in the CPI tends to push optimal monetary policy in an expansionary direction. The net effect, considering also the traditional channel, however, depends on the nature of the initial disturbance.

Suggested Citation

  • Marianne Nessén & Ulf Söderström, 2001. "Core Inflation and Monetary Policy," International Finance, Wiley Blackwell, vol. 4(3), pages 401-439.
    • Handle: RePEc:bla:intfin:v:4:y:2001:i:3:p:401-439
    DOI: 10.1111/1468-2362.00080
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    1. Ashima Goyal & Ayan Kumar Pujari, 2005. "Analyzing Core Inflation in India: A Structural VAR Approach," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(2), pages 76-90, May.
    2. Michael Krause & Wolfgang Lemke, 2006. "Optimal Monetary Policy Response to Distortionary Tax Changes," Computing in Economics and Finance 2006 306, Society for Computational Economics.
    3. Berg, Claes & Jansson, Per & Vredin, Anders, 2004. "How Useful are Simple Rules for Monetary Policy? The Swedish Experience," Working Paper Series 169, Sveriges Riksbank (Central Bank of Sweden).
    4. Jamie Armour, 2006. "An Evaluation of Core Inflation Measures," Staff Working Papers 06-10, Bank of Canada.
    5. Vadim Napalkov & Anna Novak & Andrey Shulgin, 2021. "Variations in the Effects of a Single Monetary Policy: The Case of Russian Regions," Russian Journal of Money and Finance, Bank of Russia, vol. 80(1), pages 3-45, March.
    6. Emma Bylund & Jens Iversen & Anders Vredin, 2024. "Monetary Policy in Sweden After the End of Bretton Woods," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 66(3), pages 535-590, September.
    7. Ladi R. Bala-Keffi & Donald G. Mbaka & Nuruddeen Usman, 2020. "Alternative Core Inflation Measures in Nigeria: An Examination," Applied Economics and Finance, Redfame publishing, vol. 7(4), pages 112-120, July.
    8. Dillén, Hans, 2002. "Inflation Targeting and the Dynamics of the Transmission Mechanism," Working Paper Series 141, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jul 2004.

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    More about this item

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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