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Core Inflation and Monetary Policy

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  • M. Nessen
  • U. Söderström

Abstract

What are the implications of targeting different measures of inflation? We extend a basic theoretical framework of optimal monetary policy under inflation targeting to include several components of CPI inflation, and analyze the implications of using different measures of inflation as target variable--core inflation, CPI excluding interest rates, and headline CPI inflation. Our main results are the following. (i ) Barring the interest rate component, temporary shocks to inflation do not affect optimal monetary policy under any regime. (ii) Indirect (second-round) effects of disturbances on goal variables need to be accounted for properly. Simply excluding seemingly temporary disturbances from the reaction function risks leading to inappropriate policy responses. (iii) It may be optimal to respond to changes in one measure of inflation even if the target is defined in terms of another. (iv ) The presence of the direct interest rate component in the CPI tends to push optimal monetary policy in an expansionary direction. The net effect, considering also the traditional channel, however, depends on the nature of the initial disturbance.

Suggested Citation

  • M. Nessen & U. Söderström, 2001. "Core Inflation and Monetary Policy," DNB Staff Reports (discontinued) 67, Netherlands Central Bank.
  • Handle: RePEc:dnb:staffs:67
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    References listed on IDEAS

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    1. Michael F. Bryan & Stephen G. Cecchetti & Rodney L. Wiggins, 1997. "Efficient inflation estimation," Working Paper 9707, Federal Reserve Bank of Cleveland.
    2. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
    3. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
    4. Quah, Danny & Vahey, Shaun P, 1995. "Measuring Core Inflation?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1130-1144, September.
    5. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters,in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
    6. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    7. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    8. Stephen G. Cecchetti, 1997. "Measuring short-run inflation for central bankers," Review, Federal Reserve Bank of St. Louis, issue May, pages 143-155.
    9. Michael F. Bryan & Stephen G. Cecchetti, 1994. "Measuring Core Inflation," NBER Chapters,in: Monetary Policy, pages 195-219 National Bureau of Economic Research, Inc.
    10. Apel, Mikael & Jansson, Per, 1999. "A Parametric Approach for Estimating Core Inflation and Interpreting the Inflation Process," Working Paper Series 80, Sveriges Riksbank (Central Bank of Sweden).
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    Citations

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    Cited by:

    1. Gust, Christopher & Leduc, Sylvain & Sheets, Nathan, 2009. "The adjustment of global external balances: Does partial exchange-rate pass-through to trade prices matter?," Journal of International Economics, Elsevier, vol. 79(2), pages 173-185, November.
    2. Jeffery D. Amato & Andrew Filardo & Gabriele Galati & Goetz von Peter & Feng Zhu, 2005. "Research on exchange rates and monetary policy: an overview," BIS Working Papers 178, Bank for International Settlements.
    3. Ashima Goyal & Ayan Kumar Pujari, 2005. "Analyzing Core Inflation in India: A Structural VAR Approach," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(2), pages 76-90, May.
    4. Berg, Claes & Jansson, Per & Vredin, Anders, 2004. "How Useful are Simple Rules for Monetary Policy? The Swedish Experience," Working Paper Series 169, Sveriges Riksbank (Central Bank of Sweden).
    5. Virginie Traclet, 2004. "Monetary and Fiscal Policies in Canada: Some Interesting Principles for EMU?," Staff Working Papers 04-28, Bank of Canada.
    6. Dillén, Hans, 2002. "Inflation Targeting and the Dynamics of the Transmission Mechanism," Working Paper Series 141, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jul 2004.
    7. Matteo Luciani, 2004. "A VAR Model for the Analysis of the Effects of Monetary Policy in the Euro Area," Rivista di Politica Economica, SIPI Spa, vol. 94(6), pages 175-214, November-.
    8. Michael Krause & Wolfgang Lemke, 2006. "Optimal Monetary Policy Response to Distortionary Tax Changes," Computing in Economics and Finance 2006 306, Society for Computational Economics.
    9. Jamie Armour, 2006. "An Evaluation of Core Inflation Measures," Staff Working Papers 06-10, Bank of Canada.

    More about this item

    Keywords

    Inflation targeting; underlying inflation; CPI; CPIX.;

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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