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Optimal monetary policy with distinct core and headline inflation rates

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  • Martin Bodenstein
  • Christopher J. Erceg
  • Luca Guerrieri

Abstract

In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well-approximated by policies that stabilize the output gap, but also by a wide array of \"dual mandate\" policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.

Suggested Citation

  • Martin Bodenstein & Christopher J. Erceg & Luca Guerrieri, 2008. "Optimal monetary policy with distinct core and headline inflation rates," International Finance Discussion Papers 941, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:941
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    References listed on IDEAS

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    Keywords

    Monetary policy; Energy industries; Prices; Inflation (Finance);
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