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Inflation Persistence and Optimal Monetary Policy in the Euro Area

  • Benigno, Pierpaolo
  • Lopez-Salido, J. David

In this paper we present an optimizing-agent model for the euro area to emphasize how the existence of heterogeneity in inflation persistence across regions matters for the design of monetary policy. We find supporting evidence of the existence of such a heterogeneity in inflation dynamics across euro area countries. In particular, based on the estimation of New Keynesian Phillips Curves for five major countries of the euro area, we find that inflation in Germany has a dominant forward-looking component, while in the other group of countries inflation show a significant inertial (backward looking) behavior. Under this circumstance, we study the welfare implications of four monetary policy rules following terms-of-trade shocks: fully optimal, optimal inflation targeting, HICP targeting, and output gap stabilization.

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File URL: http://dx.doi.org/10.1353/mcb.2006.0038
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 38 (2006)
Issue (Month): 3 (April)
Pages: 587-614

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Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:3:p:587-614
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