What inflation measure should a currency union target?

William Barnett, Chan Wang, Xue Wang and Liyuan Wu
Additional contact information
Xue Wang: Department of Finance, Jinan University, Guangzhou, China
Liyuan Wu: Guanghua School of Management, Peking University, Beijing, China

No 201805, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.

Keywords: Core inflation; Headline inflation; Optimal monetary policy; Currency union; Welfare. (search for similar items in EconPapers)
JEL-codes: E5 F3 F4 (search for similar items in EconPapers)
Date: 2018-05, Revised 2018-05
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: What inflation measure should a currency union target? (2019)
Working Paper: What inflation measure should a currency union target? (2018)
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