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What measure of inflation should a developing country central bank target?

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  • Anand, Rahul
  • Prasad, Eswar S.
  • Zhang, Boyang

Abstract

In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We analyze this result in the context of developing economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. We develop an open economy model with incomplete financial markets to show that headline inflation targeting improves welfare outcomes. We also compute the optimal price index, which includes a positive weight on food prices but, unlike headline inflation, assigns zero weight to import prices.

Suggested Citation

  • Anand, Rahul & Prasad, Eswar S. & Zhang, Boyang, 2015. "What measure of inflation should a developing country central bank target?," Journal of Monetary Economics, Elsevier, vol. 74(C), pages 102-116.
  • Handle: RePEc:eee:moneco:v:74:y:2015:i:c:p:102-116
    DOI: 10.1016/j.jmoneco.2015.06.006
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    Cited by:

    1. Pierre JACQUET & Alexis ATLANI & Marwan LISSER, 2017. "Policy responses to terms of trade shocks," Working Papers P205, FERDI.
    2. Rafael Portillo & Luis-Felipe Zanna & Stephen O’Connell & Richard Peck, 2016. "Implications of food subsistence for monetary policy and inflation," Oxford Economic Papers, Oxford University Press, vol. 68(3), pages 782-810.
    3. Nepal Rastra Bank Research Department NRB, 2017. "Optimal Inflation Rate for Nepal," Working Papers id:12120, eSocialSciences.
    4. Prasad, Eswar & Zhang, Boyang, 2015. "Distributional Effects of Monetary Policy in Emerging Market Economies," IZA Discussion Papers 9272, Institute for the Study of Labor (IZA).
    5. Pierre JACQUET & Alexis ATLANI & Marwan LISSER, 2017. "Policy responses to terms of trade shocks," Working Papers P205, FERDI.
    6. Miles Parker, 2016. "Global inflation: the role of food, housing and energy prices," Reserve Bank of New Zealand Discussion Paper Series DP2016/05, Reserve Bank of New Zealand.
    7. Bhattacharya, Rudrani, 2017. "Effectiveness of monetary policy in stabilising food inflation: Evidence from advanced and emerging economies," Working Papers 17/209, National Institute of Public Finance and Policy.
    8. Ryan Niladri Banerjee & Aaron Mehrotra, 2018. "Deflation expectations," BIS Working Papers 699, Bank for International Settlements.

    More about this item

    Keywords

    Inflation targeting; Monetary policy framework; Core inflation; Headline inflation; Financial frictions;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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