## What Measure of Inflation Should a Developing Country Central Bank Target?

_IMF Working Papers, September 23, 2015_

## Source details

**Canonical URL:** [What Measure of Inflation Should a Developing Country Central Bank Target?](https://www.imf.org/en/publications/wp/issues/2016/12/31/what-measure-of-inflation-should-a-developing-country-central-bank-target-43301)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/31/what-measure-of-inflation-should-a-developing-country-central-bank-target-43301/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/31/what-measure-of-inflation-should-a-developing-country-central-bank-target-43301/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/31/what-measure-of-inflation-should-a-developing-country-central-bank-target-43301/bundle-manifest.json)

## Bibliographic details
- Authors: Rahul Anand, Eswar S Prasad, Boyang Zhang
- Published: September 23, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513572574.001

---

### Summary
- In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium.
- The paper analyzes this result for developing economies characterized by:
  - a large proportion of households that are credit constrained, and
  - a high share of food expenditures in total consumption expenditures.
- An open economy model with incomplete financial markets is developed to show that headline inflation targeting improves welfare outcomes.
- The optimal price index computed in the paper:
  - includes a positive weight on food prices, and
  - unlike headline inflation, assigns zero weight to import prices.

### Model and Main Findings
- Model type: open economy model with incomplete financial markets.
- Key mechanisms highlighted:
  - Credit constraints among households alter the welfare implications of inflation-targeting rules derived under complete-market assumptions.
  - High share of food in consumption leads to different optimal weighting of food prices in an objective price index.
- Main comparative result:
  - Under complete markets (closed or open economy), core inflation targeting maximizes welfare by replicating the flexible price equilibrium.
  - Under incomplete financial markets relevant for developing economies, headline inflation targeting yields improved welfare outcomes relative to core inflation targeting.

### Optimal Price Index
- Computed characteristics:
  - Positive weight on food prices.
  - Zero weight on import prices (distinguishing it from headline inflation).

### Policy Implications
- For developing country central banks operating in environments with widespread credit constraints and high food expenditure shares, headline inflation targeting may be more welfare-improving than core inflation targeting derived from complete-market models.
- The optimal targeting index for such economies should incorporate food-price movements while excluding import prices.

---

## Content in this bundle

- **_wp15205**
  - [_wp15205 (Markdown version)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15205.pdf.md){rel="alternate" type="text/markdown"}
  - [_wp15205 (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15205.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/what-measure-of-inflation-should-a-developing-country-central-bank-target-43301_