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World Food Prices and Monetary Policy

  • Luis Catão
  • Roberto Chang

In recent years, large fluctuations in world food prices have renewed interest in the question of how monetary policy in small open economies should react to imported price shocks. We address this issue in an open economy setting similar to previous ones except that food plays a distinctive role in utility. A key novelty of our model is that the real exchange rate and the terms of trade can move in opposite directions in response to food price shocks. This has several consequences for observables and for policy. Under a variety of model calibrations, broad CPI targeting emerges as welfare-superior to alternative policy rules once the variance of food price shocks is as large as in real world data.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16563.

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Date of creation: Dec 2010
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Publication status: published as Catão, Luis A.V. & Chang, Roberto, 2015. "World food prices and monetary policy," Journal of Monetary Economics, Elsevier, vol. 75(C), pages 69-88.
Handle: RePEc:nbr:nberwo:16563
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  1. Jordi Galí & Tommaso Monacelli, 2003. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Working Papers 11, Barcelona Graduate School of Economics.
  2. David S. Jacks & Kevin H. O'Rourke & Jeffrey G. Williamson, 2011. "Commodity Price Volatility and World Market Integration since 1700," The Review of Economics and Statistics, MIT Press, vol. 93(3), pages 800-813, August.
  3. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  4. Sam Schulhofer-Wohl, 2011. "Heterogeneity and tests of risk sharing," Staff Report 462, Federal Reserve Bank of Minneapolis.
  5. Faia, Ester & Monacelli, Tommaso, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," CEPR Discussion Papers 5522, C.E.P.R. Discussion Papers.
  6. Alan Sutherland, 2002. "Incomplete Pass-Through and the Welfare Effects of Exchange Rate Variability," Discussion Paper Series, Department of Economics 200212, Department of Economics, University of St. Andrews.
  7. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2010. "Optimal monetary policy in open economies," Working Paper Series 2010-13, Federal Reserve Bank of San Francisco.
  8. Chang, Roberto, 1998. "Credible Monetary Policy in an Infinite Horizon Model: Recursive Approaches," Journal of Economic Theory, Elsevier, vol. 81(2), pages 431-461, August.
  9. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," Departmental Working Papers 200106, Rutgers University, Department of Economics.
  10. Rose, Andrew K., 2007. "A stable international monetary system emerges: Inflation targeting is Bretton Woods, reversed," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 663-681, September.
  11. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
  12. Bianca De Paoli, 2004. "Monetary policy and welfare in a small open economy," LSE Research Online Documents on Economics 19950, London School of Economics and Political Science, LSE Library.
  13. Benigno, Pierpaolo & Woodford, Michael, 2006. "Linear-Quadratic Approximation of Optimal Policy Problems," CEPR Discussion Papers 5964, C.E.P.R. Discussion Papers.
  14. 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.).
  15. Benigno, Gianluca & Benigno, Pierpaolo, 2003. "Designing targeting rules for international monetary policy cooperation," Working Paper Series 0279, European Central Bank.
  16. Jens Sondergaard & Pietro Cova, 2004. "When Should Monetary Policy Target The Exchange Rate?," Royal Economic Society Annual Conference 2004 51, Royal Economic Society.
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