Real indeterminacy and the timing of money in open economies

Stephen McKnight

Serie documentos de trabajo del Centro de Estudios Económicos from El Colegio de México, Centro de Estudios Económicos

Abstract: Should central banks target producer price inflation or consumer price inflation in the setting of monetary policy? Previous studies suggest that in order to avoid real indeterminacy and self-fulfilling fluctuations, the interest rate rule for open economies should react to producer price inflation. However, as this paper shows, the preference towards a particular inflation index crucially depends upon the timing assumption on money employed in the determinacy analysis. This timing assumption importantly determines the transactions-facilitating services of money. It is shown that the conclusions of the existing literature, that advocate targeting producer price inflation, is a by-product of adopting end-of-period timing, i.e. what matters for transactions purposes is the money one leaves the goods market with. However, we find that the conditions for equilibrium determinacy change significantly once cash-in-advance timing is adopted, i.e. what matters for current transactions is the money one enters the goods market with. Thus in stark contrast to previous studies, we show that under cash-in-advance timing, targeting consumer price inflation is preferable to targeting producer price inflation in preventing self-fulfilling expectations.

Keywords: real indeterminacy; open economy monetary models; trade openness; interest rate rules (search for similar items in EconPapers)
JEL-codes: E32 E43 E53 E58 F41 (search for similar items in EconPapers)
Date: 2011-03
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 (3)

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Related works:
Working Paper: Real Indeterminacy and the Timing of Money in Open Economies (2007)
Working Paper: Real Indeterminacy and the Timing of Money in Open Economies (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:emx:ceedoc:2011-01

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