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Sticky Wages, Incomplete Pass-Through and Inflation Targeting: What is the Right Index to Target?

  • Abo-Zaid, Salem

This paper studies optimal monetary policy in a small open economy with Inflation Targeting, incomplete pass-through and rigid nominal wages. The paper shows that the right index to target depends on the structure of the individual economy. When wages are fully flexible, the consumer price index (CPI) is better to target given low to moderate levels of pass-through. On the other hand, assuming complete pass-through, economies with relatively high degrees of wage rigidity and wage indexation should either target their CPIs or fully stabilize nominal wages. Also, CPI targeting and nominal wage targeting are superior to targeting the Producer Price Index (DPI) in relatively high degrees of pass-through given that wages are relatively rigid and indexation degrees are high. The results of the paper suggest that, by committing to a common monetary policy in a common-currency area, some countries may not be conducting monetary policy optimally.

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File URL: http://mpra.ub.uni-muenchen.de/13177/1/MPRA_paper_13177.pdf
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File URL: http://mpra.ub.uni-muenchen.de/16966/1/MPRA_paper_16966.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13177.

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Date of creation: 05 Feb 2009
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Handle: RePEc:pra:mprapa:13177
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  1. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  2. Jose Manuel Campa & Linda S. Goldberg & Jose M. Gonzalez-Minguez, 2005. "Exchange rate pass-through to import prices in the Euro area," Staff Reports 219, Federal Reserve Bank of New York.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  4. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," Trinity Economics Papers 200111, Trinity College Dublin, Department of Economics.
  5. Alessia Campolmi, 2006. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Economics Working Papers 961, Department of Economics and Business, Universitat Pompeu Fabra.
  6. Mark Gertler & Lars Svensson & Andrea Ferrero, 2008. "Current Account Dynamics and Monetary Policy," 2008 Meeting Papers 359, Society for Economic Dynamics.
  7. Böckerman, Petri & Laaksonen, Seppo & Vainiomäki, Jari, 2006. "Micro-level evidence on wage rigidities in Finland," MPRA Paper 1811, University Library of Munich, Germany.
  8. K. Huang & Z. Liu, . "Staggered price-setting, staggered wage-setting, and business cycle persistence," Working Papers 2000-28, Utah State University, Department of Economics.
  9. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  10. Mark Toma, 2001. "Monetary policy," Chapters, in: The Elgar Companion to Public Choice, chapter 21 Edward Elgar.
  11. Olivier Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Working Papers 05-14, Federal Reserve Bank of Boston.
  12. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  13. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers.
  14. Campa, José Manuel & Goldberg, Linda S., 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
  15. Flamini, Alessandro, 2007. "Inflation targeting and exchange rate pass-through," Journal of International Money and Finance, Elsevier, vol. 26(7), pages 1113-1150, November.
  16. Bodart, Vincent & De Walque, Gregory & Pierrard, Olivier & Sneessens, Henri R. & Wouters, Raf, 2006. "Nominal Wage Rigidities in a New Keynesian Model with Frictional Unemployment," IZA Discussion Papers 2528, Institute for the Study of Labor (IZA).
  17. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
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