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Cost-push shocks and monetary policy in open economies

  • Alan Sutherland

This paper analyses the implications of cost-push shocks for the optimal choice of monetary policy target in a two-country sticky-price model. In addition to cost-push shocks, each country is subject to labour-supply and money-demand shocks. It is shown that the fully optimal coordinated policy can be supported by independent national monetary authorities following a policy of flexible inflation targeting. A number of simple (but non-optimal) targeting rules are compared. Strict producer-price targeting is found to be the best simple rule when the variance of cost-push shocks is small. Strict consumer-price targeting is best for intermediate levels of the variance of cost-push shocks. And nominal-income targeting is best when the variance of cost-push shocks is high. In general, money-supply targeting and fixed nominal exchange rates are found to yield less welfare than these other regimes. Copyright 2005, Oxford University Press.

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Article provided by Oxford University Press in its journal Oxford Economic Papers.

Volume (Year): 57 (2005)
Issue (Month): 1 (January)
Pages: 1-33

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Handle: RePEc:oup:oxecpp:v:57:y:2005:i:1:p:1-33
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