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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: https://mpra.ub.uni-muenchen.de/13177/1/MPRA_paper_13177.pdf
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File URL: https://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. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
  2. Huang, Kevin X. D. & Liu, Zheng, 2002. "Staggered price-setting, staggered wage-setting, and business cycle persistence," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 405-433, March.
  3. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  4. A. Campolmi, 2005. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Working Papers 553, Dipartimento Scienze Economiche, Universita' di Bologna.
  5. Flamini, Alessandro, 2007. "Inflation targeting and exchange rate pass-through," Journal of International Money and Finance, Elsevier, vol. 26(7), pages 1113-1150, November.
  6. Olivier Jean Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  7. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  9. Andrea Ferrero & Mark Gertler & Lars E. O. Svensson, 2008. "Current account dynamics and monetary policy," Working Paper Series 2008-26, Federal Reserve Bank of San Francisco.
  10. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEG Working Papers 20017, Trinity College Dublin, Department of Economics.
  11. Vincent Bodart & Gregory de Walque & Olivier Pierrard & Henri R. Sneessens & Raf Wouters, 2006. "Nominal wage rigidities in a new Keynesian model with frictional unemployment," Working Paper Research 97, National Bank of Belgium.
  12. Böckerman, Petri & Laaksonen, Seppo & Vainiomäki, Jari, 2006. "Micro-level evidence on wage rigidities in Finland," MPRA Paper 1811, University Library of Munich, Germany.
  13. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  14. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  15. Mark Toma, 2001. "Monetary policy," Chapters, in: The Elgar Companion to Public Choice, chapter 21 Edward Elgar Publishing.
  16. 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.
  17. 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.
  18. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  19. 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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