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What Measure of Inflation Should a Developing Country Central Bank Target?

Listed author(s):
  • Rahul Anand
  • Eswar S Prasad
  • Boyang Zhang

In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We analyze this result in the context of developing economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. We develop an open economy model with incomplete financial markets to show that headline inflation targeting improves welfare outcomes. We also compute the optimal price index, which includes a positive weight on food prices but, unlike headline inflation, assigns zero weight to import prices.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 15/205.

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Length: 37
Date of creation: 23 Sep 2015
Handle: RePEc:imf:imfwpa:15/205
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