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

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  • Rahul Anand
  • Mr. Eswar S Prasad
  • Boyang Zhang

Abstract

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.

Suggested Citation

  • Rahul Anand & Mr. Eswar S Prasad & Boyang Zhang, 2015. "What Measure of Inflation Should a Developing Country Central Bank Target?," IMF Working Papers 2015/205, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2015/205
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    More about this item

    Keywords

    WP; core inflation; headline inflation; subsistence level; Inflation targeting; monetary policy framework; financial frictions; core inflation inflation targeting; headline inflation inflation targeting; food price inflation; headline inflation targeting regime result; headline inflation targeting rule; optimal price index; inflation expectation; Inflation; Sticky prices; Consumption; Price indexes; Africa; Global;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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