Efficient CPI-Based Taylor Rules in Small Open Economies

Rodrigo Caputo and Luis Oscar Herrera

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: In a standard New-Keynesian model for a small open economy, we derive the efficient CPI inflationbased Taylor rule. We conclude that the natural rate of interest, based on CPI inflation, must be directly linked to the foreign interest rate, as well as to domestic productivity shocks. In this way this rule ensures that the real ex-ante CPI interest rate moves in the face of domestic and foreign shocks so as to induce efficient movements in consumption. The empirical evidence, on the other hand, shows that inflation-targeting central banks respond to movements in the foreign interest rate (Fed funds rate), besides reacting to expected CPI inflation and to the domestic output gap.

Date: 2013-07
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:chb:bcchwp:694

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