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Cost-push shocks and monetary policy in open economies

Alan Sutherland ()

Oxford Economic Papers, 2005, vol. 57, issue 1, 1-33

Abstract: This paper analyses the implications of cost-push shocks for the optimal choice of monetary policy target in a two-country sticky-price model. In addition to cost-push shocks, each country is subject to labour-supply and money-demand shocks. It is shown that the fully optimal coordinated policy can be supported by independent national monetary authorities following a policy of flexible inflation targeting. A number of simple (but non-optimal) targeting rules are compared. Strict producer-price targeting is found to be the best simple rule when the variance of cost-push shocks is small. Strict consumer-price targeting is best for intermediate levels of the variance of cost-push shocks. And nominal-income targeting is best when the variance of cost-push shocks is high. In general, money-supply targeting and fixed nominal exchange rates are found to yield less welfare than these other regimes. Copyright 2005, Oxford University Press.

Date: 2005
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