Optimal Monetary Policy and the Sources of Local-Currency Price Stability

Giancarlo Corsetti, Luca Dedola (luca.dedola@ecb.int) and Sylvain Leduc

No 6557, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favour of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.

Keywords: Exchange rate pass-through; Optimal monetary policy; Price discrimination; Price dispersion; Real exchange rates (search for similar items in EconPapers)
JEL-codes: F31 F33 F41 (search for similar items in EconPapers)
Date: 2007-11
New Economics Papers: this item is included in nep-cba
References: Add references at CitEc
Citations: View citations in EconPapers (24)

Downloads: (external link)
https://cepr.org/publications/DP6557 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Chapter: Optimal Monetary Policy and the Sources of Local-Currency Price Stability (2007)
Working Paper: Optimal Monetary Policy and the Sources of Local-Currency Price Stability (2007)
Working Paper: Optimal Monetary Policy and the Sources of Local-Currency Price Stability (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:6557

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP6557
orders@cepr.org

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by (repec@cepr.org).