The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
In closed or open economy models with complete markets, targeting core inflation enables
monetary policy to maximize welfare by replicating the flexible price equilibrium. We
analyze this result in the context of developing economies, where a large proportion of
households are credit constrained and the share of food expenditures in total consumption
expenditures is high. We develop an open economy model with incomplete financial markets
to show that headline inflation targeting improves welfare outcomes. We also compute the
optimal price index, which includes a positive weight on food prices but, unlike headline
inflation, assigns zero weight to import prices.