Optimal Price Indices for Targeting Inflation Under Incomplete Markets
IMF Working Papers, September 1, 2010
Source details
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- Optimal Price Indices for Targeting Inflation Under Incomplete Markets
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Bibliographic details
- Authors: Rahul Anand, Eswar S Prasad
- Published: September 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455205301.001
Authors and Publication
- Authors: Rahul Anand, Eswar S Prasad
- Publication date: September 1, 2010
- Series: Working Paper No. 2010/200
- Issue: 200
- Volume: 2010
- Pages: 62
- DOI: https://doi.org/10.5089/9781455205301.001
- ISBN: 9781455205301
- ISSN: 1018-5941
- Stock No: WPIEA2010200
Research question and model
- Investigates the optimal choice of price index for inflation targeting when markets are incomplete and financial frictions are present.
- Uses a two-sector two-good new-Keynesian model to analyze policy trade-offs.
Key findings
- In models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium.
- 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.
- 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.
Policy implications and recommendations
- Monetary policy frameworks in economies with financial frictions should consider headline CPI inflation targets rather than core-only targets.
- Optimal policy involves flexible targeting: headline inflation objective combined with some attention to the output gap to maximize welfare under incomplete markets.
Subject areas and keywords
- 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
Source: IMF Working Papers — "Optimal Price Indices for Targeting Inflation Under Incomplete Markets", Rahul Anand and Eswar S Prasad, September 1, 2010.