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Optimal Monetary Policy and the Sources of Local-Currency Price Stability

In: International Dimensions of Monetary Policy

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  • Giancarlo Corsetti
  • Luca Dedola
  • Sylvain Leduc

Abstract

We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favor of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.
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  • Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2007. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," NBER Chapters, in: International Dimensions of Monetary Policy, pages 319-367, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:0527
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    Cited by:

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    2. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2010. "Optimal Monetary Policy in Open Economies," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 16, pages 861-933, Elsevier.
    3. Corsetti, Giancarlo & Crowley, Meredith & Han, Lu, 2022. "Invoicing and the dynamics of pricing-to-market: Evidence from UK export prices around the Brexit referendum," Journal of International Economics, Elsevier, vol. 135(C).
    4. Choudhri, Ehsan U. & Hakura, Dalia S., 2015. "The exchange rate pass-through to import and export prices: The role of nominal rigidities and currency choice," Journal of International Money and Finance, Elsevier, vol. 51(C), pages 1-25.
    5. Giancarlo Corsetti & Paolo Pesenti, 2009. "The Simple Geometry of Transmission and Stabilization in Closed and Open Economies," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 65-116, National Bureau of Economic Research, Inc.
    6. Giancarlo Corsetti, 2008. "A Modern Reconsideration of the Theory of Optimal Currency Areas," Economics Working Papers ECO2008/12, European University Institute.
    7. Michael Dotsey & Margarida Duarte, 2017. "How Important is the Currency Denomination of Exports in Open Economy Models?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 1-18, January.
    8. Matthieu Bussière & Simona Delle Chiaie & Tuomas A Peltonen, 2014. "Exchange Rate Pass-Through in the Global Economy: The Role of Emerging Market Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 62(1), pages 146-178, April.
    9. Charles Engel, 2011. "Currency Misalignments and Optimal Monetary Policy: A Reexamination," American Economic Review, American Economic Association, vol. 101(6), pages 2796-2822, October.
    10. David C. López-Valenzuela & Enrique Montes-Uribe & Héctor M. Zárate-Solano & Alvaro Carmona-Duarte, 2019. "Determinantes y evolución entre precios y cantidades de las exportaciones industriales de Colombia: un estudio a partir de un modelo de Panel-VAR," Borradores de Economia 1075, Banco de la Republica de Colombia.
    11. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
    12. Philippe Jeanfils, 2008. "Imperfect exchange rate pass-through : the role of distribution services and variable demand elasticity," Working Paper Research 135, National Bank of Belgium.
    13. Eiji Okano & Masataka Eguchi & Hiroshi Gunji & Tomomi Miyazaki, 2012. "Optimal Monetary Policy in an Estimated Local Currency Pricing Model," Advances in Econometrics, in: DSGE Models in Macroeconomics: Estimation, Evaluation, and New Developments, pages 39-79, Emerald Group Publishing Limited.
    14. Okano, Eiji & Eguchi, Masataka, 2021. "The Effects of Money-financed Fiscal Stimulus in a Small Open Economy," Dynare Working Papers 70, CEPREMAP.
    15. Zahra Sheidaei, 2023. "Firm specific pass through and heterogeneity," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 47(1), pages 142-156, March.
    16. Ganapati Mendali & Sanjukta Das, 2017. "Exchange Rate Pass-through to Domestic Prices," Foreign Trade Review, , vol. 52(3), pages 135-156, August.
    17. Jimborean, Ramona, 2013. "The exchange rate pass-through in the new EU member states," Economic Systems, Elsevier, vol. 37(2), pages 302-329.
    18. Aleksandr Eliseev & Anna Novak & Andrey Shulgin, 2023. "Long-Term Exchange Rate Pass-Through to Prices," Russian Journal of Money and Finance, Bank of Russia, vol. 82(2), pages 21-51, June.
    19. Riccardo DiCecio & Edward Nelson, 2010. "Euro Membership as a U.K. Monetary Policy Option: Results from a Structural Model," NBER Chapters, in: Europe and the Euro, pages 415-439, National Bureau of Economic Research, Inc.
    20. repec:zbw:bofitp:2008_025 is not listed on IDEAS
    21. Bussière, M. & Delle Chiaie, S. & Peltonen, T. A., 2013. "Exchange Rate Pass-Through in the Global Economy," Working papers 424, Banque de France.
    22. Kristin Forbes, 2016. "Much Ado about Something Important: How do Exchange Rate Movements Affect Inflation?," Manchester School, University of Manchester, vol. 84(S1), pages 15-41, September.

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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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