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Monetary policy and commodity price shocks

  • Silke Tober

    ()

    (IMK at the Hans Boeckler Foundation)

  • Tobias Zimmermann

    ()

    (Rhine-Westphalia Insitut for Economic Research (RWI))

This paper analyses the effects of commodity price shocks in a new Keynesian model. The focus is on the central bank's choice of inflation target and the degree of real wage rigidity. It turns out that using core inflation rather than headline inflation is the superior strategy. Targeting expected headline inflation, as practiced by most central banks, is a viable practical alternative to the core inflation target. Simulations illustrate these points. The introduction of real wage rigidity into the model does not change these conclusions. Real wage rigidity does, however, imply second-round effects, making the monetary policy response, the inflation peak and the output drop more pronounced. Although in practice many of the assumptions of the model, such as full information, do not hold, lessons can be drawn for monetary policy. In case of a commodity supply shock, central banks would do well to focus on some measure of core inflation rather than headline inflation so as to reduce the volatility of both inflation and output. A communication strategy that places greater emphasis on underlying and expected inflation could serve to anchor inflation expectations.

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File URL: http://www.boeckler.de/pdf/p_imk_wp_16_2008.pdf
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Paper provided by IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute in its series IMK Working Paper with number 16-2008.

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Length: 14 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:imk:wpaper:16-2008
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  1. Andrew Atkeson & Patrick J. Kehoe, 1994. "Models of Energy Use: Putty-Putty versus Putty-Clay," NBER Working Papers 4833, National Bureau of Economic Research, Inc.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. Ascari, Guido & Merkl, Christian, 2007. "Real Wage Rigidities and the Cost of Disinflations," IZA Discussion Papers 3049, Institute for the Study of Labor (IZA).
  4. Lenza, Michele, 2007. "Monetary policy and core inflation," Discussion Paper Series 1: Economic Studies 2007,35, Deutsche Bundesbank, Research Centre.
  5. Romain Duval & Lukas Vogel, 2008. "Oil Price Shocks, Rigidities and the Conduct of Monetary Policy: Some Lessons from a New Keynesian Perspective," OECD Economics Department Working Papers 603, OECD Publishing.
  6. Robert E. Hall, 2005. "Separating the business cycle from other economic fluctuations," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 133-179.
  7. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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