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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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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
Date of revision:
Handle: RePEc:pra:mprapa:13177
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  1. Olivier Jean Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Working Papers 05-14, Federal Reserve Bank of Boston.
  2. 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.
  3. Campa, José Manuel & Goldberg, Linda S., 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
  4. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
  5. K. Huang & Z. Liu, . "Staggered price-setting, staggered wage-setting, and business cycle persistence," Working Papers 2000-28, Utah State University, Department of Economics.
  6. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  7. Campa, Jose M. & Goldberg, Linda S. & Gonzalez-Minguez, Jose M., 2005. "Exchange-rate pass-through to import prices in the euro area," IESE Research Papers D/609, IESE Business School.
  8. 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).
  9. 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.
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  11. Mark Toma, 2001. "Monetary policy," Chapters, in: The Elgar Companion to Public Choice, chapter 21 Edward Elgar.
  12. 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.
  13. Böckerman, Petri & Laaksonen, Seppo & Vainiomäki, Jari, 2006. "Micro-level evidence on wage rigidities in Finland," MPRA Paper 1811, University Library of Munich, Germany.
  14. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  15. Alessandro Flamini, 2004. "Inflation Targeting and Exchange Rate Pass-Through," IHEID Working Papers 04-2004, Economics Section, The Graduate Institute of International Studies.
  16. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  17. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  18. Andrea Ferrero & Mark Gertler & Lars E. O. Svensson, 2007. "Current Account Dynamics and Monetary Policy," NBER Chapters, in: International Dimensions of Monetary Policy, pages 199-244 National Bureau of Economic Research, Inc.
  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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