Optimal monetary policy with distinct core and headline inflation rates

Martin Bodenstein, Christopher John Erceg and Luca Guerrieri

Journal of Monetary Economics, 2008, vol. 55, issue Supplement 1, pages S18-S33

Abstract: In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well approximated by policies that stabilize the output gap, but also by a wide array of "dual mandate" policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.

Keywords: Energy; price; shocks; Monetary; policy; tradeoffs; DSGE; models (search for similar items in EconPapers)
Date: 2008
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Persistent link: http://EconPapers.repec.org/RePEc:eee:moneco:v:55:y:2008:i:s1:p:s18-s33

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