IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Inflation targeting and exchange rate pass-through

  • Flamini, Alessandro

This paper analyzes how endogenous imperfect exchange rate pass-through affects inflation targeting optimal monetary policies in a New Keynesian small open economy. The paper shows that an inverse relation exists between the pass-through and the insulation of the economy from foreign and monetary policy shocks, and that imperfect pass-through tends to decrease the variability of the terms of trade. Furthermore, with CPI inflation targeting, in the short run, delayed pass-through constrains monetary policy more than incomplete pass-through and interest rate smoothing amplifies this effect. When the pass-through decreases, the variability in economic activity tends to raise and the trade-of between the stabilization of CPI inflation and output worsens in direct relation to how strictly the central bank is targeting CPI inflation. In contrast, with domestic inflation targeting, optimal monetary policy is not constrained and opposite results occur. Consequently, imperfect pass-through favors the choice of domestic to CPI inflation targeting.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/B6V9S-4P7FS5D-1/2/d5ccbfa1d9211e612bf17bbb617690bc
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 26 (2007)
Issue (Month): 7 (November)
Pages: 1113-1150

as
in new window

Handle: RePEc:eee:jimfin:v:26:y:2007:i:7:p:1113-1150
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  2. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  3. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
  4. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  5. Devereux, Michael B & Engel, Charles M & Storgaard, Peter Ejler, 2002. "Endogenous Exchange Rate Pass-Through When Nominal Prices Are Set in Advance," CEPR Discussion Papers 3608, C.E.P.R. Discussion Papers.
  6. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 01-90, Wharton School Rodney L. White Center for Financial Research.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  8. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  9. repec:cup:cbooks:9780521441964 is not listed on IDEAS
  10. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers 3355, C.E.P.R. Discussion Papers.
  11. Sutherland, Alan, 2005. "Incomplete pass-through and the welfare effects of exchange rate variability," Journal of International Economics, Elsevier, vol. 65(2), pages 375-399, March.
  12. Raf Wouters & Frank Smets, 2005. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE Approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 161-183.
  13. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers C99-107, University of California at Berkeley.
  14. Hasan Bakhshi & Hashmat Khan & Barbara Rudolf, 2005. "The Phillips curve under state-dependent pricing," Working Papers 2005-01, Swiss National Bank.
  15. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," Trinity Economics Papers 200111, Trinity College Dublin, Department of Economics.
  16. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
  17. Burstein, Ariel Tomas & Neves, Joao C & Rebelo, Sérgio, 2001. "Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilization," CEPR Discussion Papers 2944, C.E.P.R. Discussion Papers.
  18. P. Bacchetta & E. van Wincoop, 2002. "A Theory of the Currency Denomination of International Trade," DNB Staff Reports (discontinued) 75, Netherlands Central Bank.
  19. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
  20. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  21. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  22. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?," NBER Working Papers 8934, National Bureau of Economic Research, Inc.
  23. Michael B. Devereux & Charles Engel, 2001. "Endogenous Currency of Price Setting in a Dynamic Open Economy Model," NBER Working Papers 8559, National Bureau of Economic Research, Inc.
  24. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  25. Sven W. Arndt & J. David Richardson, 1987. "Real-Financial Linkages Among Open Economies," NBER Working Papers 2230, National Bureau of Economic Research, Inc.
  26. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  27. Eiji Fuji & Jeannine Bailliu, 2004. "Exchange Rate Pass-Through and the Inflation Environment in Industrialized Countries: An Empirical Investigation," Computing in Economics and Finance 2004 135, Society for Computational Economics.
  28. Amit Kara & Edward Nelson, 2002. "The Exchange Rate and Inflation in the UK," Discussion Papers 11, Monetary Policy Committee Unit, Bank of England.
  29. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  30. Ganelli, Giovanni & Lane, Philip R., 2002. "Dynamic General Equilibrium Analysis: The Open Economy Dimension," CEPR Discussion Papers 3540, C.E.P.R. Discussion Papers.
  31. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
  32. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
  33. Bacchetta, Philippe & van Wincoop, Eric, 2002. "A Theory of Currency Denomination of International Trade," CEPR Discussion Papers 3120, C.E.P.R. Discussion Papers.
  34. Knetter, Michael M, 1989. "Price Discrimination by U.S. and German Exporters," American Economic Review, American Economic Association, vol. 79(1), pages 198-210, March.
  35. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  36. Ryan Banerjee & Nicoletta Batini, 2003. "UK Consumers’ Habits," Discussion Papers 13, Monetary Policy Committee Unit, Bank of England.
  37. Dalia Hakura & Ehsan U. Choudhri, 2001. "Exchange Rate Pass-Through to Domestic Prices; Does the Inflationary Environment Matter?," IMF Working Papers 01/194, International Monetary Fund.
  38. Engel, Charles, 2002. "The Responsiveness of Consumer Prices to Exchange Rates: A Synthesis of Some New Open Economy Macro Models," Manchester School, University of Manchester, vol. 70(0), pages 1-15, Supplemen.
  39. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
  40. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:jimfin:v:26:y:2007:i:7:p:1113-1150. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.