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Optimal monetary policy with distinct core and headline inflation rates

Author Info

  • Bodenstein, Martin
  • Erceg, Christopher J.
  • Guerrieri, Luca

Abstract

In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well approximated by policies that stabilize the output gap, but also by a wide array of "dual mandate" policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.

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File URL: http://www.sciencedirect.com/science/article/pii/S0304-3932(08)00105-0
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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 55 (2008)
Issue (Month): Supplement 1 (October)
Pages: S18-S33

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Handle: RePEc:eee:moneco:v:55:y:2008:i:s1:p:s18-s33
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

Keywords: Energy price shocks Monetary policy tradeoffs DSGE models;

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  1. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
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  7. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  8. Rajeev Dhawan & Karsten Jeske, 2007. "Taylor rules with headline inflation: a bad idea," FRB Atlanta Working Paper 2007-14, Federal Reserve Bank of Atlanta.
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