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

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

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.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 74 (2015)
Issue (Month): C ()
Pages: 102-116

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Handle: RePEc:eee:moneco:v:74:y:2015:i:c:p:102-116
DOI: 10.1016/j.jmoneco.2015.06.006
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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