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Currency misalignments, international trade in intermediate inputs, and inflation targeting

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  • Gong, Liutang
  • Wang, Chan
  • Wu, Liyuan
  • Zou, Heng-fu

Abstract

In the literature on optimal monetary policy in open economies, the presence of local- currency pricing provides a rationale for targeting CPI inflation rather than PPI inflation. In this paper, we reexamine this conclusion by incorporating international trade in intermediate inputs into Engel (2011). We find that the cooperative monetary policymaker should target the final-goods output gaps, the PPI inflation rates at both stages of production, the currency misalignments at both stages of production, and the vertical relative price gaps. Welfare analysis shows that the monetary policymaker should target the weighted average intermediate-goods PPI (WPPI) inflation rather than CPI inflation for most combinations of price stickiness at both stages of production.

Suggested Citation

  • Gong, Liutang & Wang, Chan & Wu, Liyuan & Zou, Heng-fu, 2023. "Currency misalignments, international trade in intermediate inputs, and inflation targeting," Journal of International Money and Finance, Elsevier, vol. 134(C).
    • Handle: RePEc:eee:jimfin:v:134:y:2023:i:c:s026156062300044x
    DOI: 10.1016/j.jimonfin.2023.102843
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    More about this item

    Keywords

    Vertical production and trade; Optimal monetary policy; Inflation targeting; Welfare;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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