Arbeitspapier
Optimal price indices for targeting inflation under incomplete markets
In models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. In this paper, we develop a twosector two-good closed economy new Keynesian model to study the optimal choice of price index in markets with financial frictions. Financial frictions that limit credit-constrained consumers' access to financial markets make demand insensitive to interest rate fluctuations. The demand of credit-constrained consumers is determined by their real wage, which depends on prices in the flexible price sector. Thus, prices in the flexible price sector influence aggregate demand and, for monetary policy to have its desired effect, the central bank has to stabilize price movements in the flexible price sector. Also, in the presence of financial frictions, stabilizing core inflation is no longer equivalent to stabilizing output fluctuations. Our analysis suggests that in the presence of financial frictions a welfaremaximizing central bank should adopt flexible headline inflation targeting - a target based on headline rather than core inflation, and with some weight on the output gap. We discuss why 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.
- Language
-
Englisch
- Bibliographic citation
-
Series: IZA Discussion Papers ; No. 5137
- Classification
-
Wirtschaft
Price Level; Inflation; Deflation
Monetary Policy
Policy Objectives; Policy Designs and Consistency; Policy Coordination
- Subject
-
inflation targeting
monetary policy framework
core inflation
headline inflation
financial frictions
liquidity constraints
- Event
-
Geistige Schöpfung
- (who)
-
Anand, Rahul
Prasad, Eswar S.
- Event
-
Veröffentlichung
- (who)
-
Institute for the Study of Labor (IZA)
- (where)
-
Bonn
- (when)
-
2010
- Handle
- URN
-
urn:nbn:de:101:1-201010133398
- Last update
-
10.03.2025, 11:41 AM CET
Data provider
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Anand, Rahul
- Prasad, Eswar S.
- Institute for the Study of Labor (IZA)
Time of origin
- 2010
Other Objects (12)
Optimal Price Indices for Targeting Inflation under Incomplete Markets
Price-Level Targeting – a Viable Alternative to Inflation Targeting?
Price-level targeting versus inflation targeting over the long-term
Price-level Targeting versus Inflation Targeting in a Forward-looking Model
Price customization and targeting in platform markets
Price level versus inflation targeting under model uncertainty
Price-level targeting and inflation expectations: Experimental evidence
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Inflation targeting
Foreign price shocks and inflation targeting: Effects on income and inflation inequality
Equilibrium and arbitrage in incomplete asset markets with fixed prices
Optimal Price Indices for Targeting Inflation under Incomplete Markets
Price-Level Targeting – a Viable Alternative to Inflation Targeting?
Price-level targeting versus inflation targeting over the long-term
Price-level Targeting versus Inflation Targeting in a Forward-looking Model
Price customization and targeting in platform markets
Price level versus inflation targeting under model uncertainty
Price-level targeting and inflation expectations: Experimental evidence
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Inflation targeting
Foreign price shocks and inflation targeting: Effects on income and inflation inequality
Equilibrium and arbitrage in incomplete asset markets with fixed prices
Optimal Price Indices for Targeting Inflation under Incomplete Markets
Price-Level Targeting – a Viable Alternative to Inflation Targeting?
Price-level targeting versus inflation targeting over the long-term
Price-level Targeting versus Inflation Targeting in a Forward-looking Model
Price customization and targeting in platform markets
Price level versus inflation targeting under model uncertainty
Price-level targeting and inflation expectations: Experimental evidence
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Does inflation targeting reduce the dispersion of price setters' inflation expectations?
Inflation targeting
Foreign price shocks and inflation targeting: Effects on income and inflation inequality