IMF Working Papers

Optimal Price Indices for Targeting Inflation Under Incomplete Markets

By Rahul Anand, Eswar S Prasad

September 1, 2010

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Rahul Anand, and Eswar S Prasad. Optimal Price Indices for Targeting Inflation Under Incomplete Markets, (USA: International Monetary Fund, 2010) accessed November 10, 2024
Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

In models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We develop a two-sector two-good new-Keynesian model to study the optimal choice of price index in markets with financial frictions. We find that, in the presence of financial frictions, a welfare-maximizing central bank should adopt flexible headline inflation targeting a target for headline CPI inflation with some weight on the output gap. These results are particularly relevant for emerging markets, where the share of food expenditures in total consumption expenditures is high and a large proportion of consumers are credit constrained.

Subject: Consumption, Inflation, Inflation targeting, Monetary policy, National accounts, Price indexes, Prices, Sticky prices

Keywords: Consumption, Consumption process, Core Inflation, Core inflation inflation targeting, Core inflation targeting regime, Elasticity of substitution, Financial Frictions, Food price inflation, Global, Headline inflation, Headline inflation inflation targeting, Headline inflation targeting rule, Inflation, Inflation targeting, Inflation targeting price index, Liquidity Constraints, Monetary Policy Framework, Price indexes, Representative core inflation targeting country, Rule allocation, Sticky price, Sticky prices, Targeting consumption, WP

Publication Details

  • Pages:

    62

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2010/200

  • Stock No:

    WPIEA2010200

  • ISBN:

    9781455205301

  • ISSN:

    1018-5941