Optimal Price Indices for Targeting Inflation Under Incomplete Markets

Author/Editor:

Rahul Anand ; Eswar S Prasad

Publication Date:

September 1, 2010

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

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.

Series:

Working Paper No. 10/200

Subject:

English

Publication Date:

September 1, 2010

ISBN/ISSN:

9781455205301/1018-5941

Stock No:

WPIEA2010200

Format:

Paper

Pages:

62

Please address any questions about this title to publications@imf.org