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

Listed author(s):
  • 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
Handle: RePEc:pra:mprapa:13177
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  2. Michael B. Devereux & Philip R. Lane & Juanyi Xu, 2006. "Exchange Rates and Monetary Policy in Emerging Market Economies," Economic Journal, Royal Economic Society, vol. 116(511), pages 478-506, 04.
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  16. Alessandro Flamini, 2004. "Inflation Targeting and Exchange Rate Pass-Through," IHEID Working Papers 04-2004, Economics Section, The Graduate Institute of International Studies.
  17. 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.
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  19. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
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