Optimal monetary policy with distinct core and headline inflation rates
Christopher Erceg and
Luca Guerrieri ()
No 941, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)
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: Monetary policy; Energy industries; Prices; Inflation (Finance) (search for similar items in EconPapers)
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