IMF Working Papers Volume 2010 Issue 200: Optimal Price Indices for Targeting Inflation Under Incomplete Markets (2010)

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Optimal Price Indices for Targeting Inflation Under Incomplete Markets

Author:

Rahul Anand

Rahul Anand
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and

Mr. Eswar S Prasad

Mr. Eswar S Prasad
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Series:: IMF Working Papers

Volume/Issue:: Volume 2010: Issue 200

Publication Date:: 01 Sep 2010

DOI:: https://doi.org/10.5089/9781455205301.001

ISBN:: 9781455205301

ISSN:: 1018-5941

Pages:: 62

Keywords:: WP; headline inflation; Inflation targeting; Monetary Policy Framework; Core Inflation; Financial Frictions; Liquidity Constraints; headline inflation inflation targeting; consumption process; core inflation inflation targeting; rule allocation; sticky price; food price inflation; elasticity of substitution; inflation targeting price index; representative core inflation targeting country; headline inflation targeting rule; targeting consumption; core inflation targeting regime; Inflation; Consumption; Sticky prices; Price indexes; Global

Legal-disclaimer:: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Series:: IMF Working Papers

Volume/Issue:: Volume 2010: Issue 200

Language:: English

Publication Date:: 01 Sep 2010

DOI:: https://doi.org/10.5089/9781455205301.001

ISBN:: 9781455205301

ISSN:: 1018-5941

Pages:: 62

Keywords:: WP; headline inflation; Inflation targeting; Monetary Policy Framework; Core Inflation; Financial Frictions; Liquidity Constraints; headline inflation inflation targeting; consumption process; core inflation inflation targeting; rule allocation; sticky price; food price inflation; elasticity of substitution; inflation targeting price index; representative core inflation targeting country; headline inflation targeting rule; targeting consumption; core inflation targeting regime; Inflation; Consumption; Sticky prices; Price indexes; Global

Legal-disclaimer:: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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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.

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IMF Working Papers

ISSN:: 1018-5941

Publisher:: International Monetary Fund

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