Core Inflation and Monetary Policy

Marianne Nessen () and Ulf Söderström ()

No 110, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: What are the implications of targeting different measures of inflation? We extend a basic theoretical framework of optimal monetary policy under inflation targeting to include several components of CPI inflation ratio, and analyze the implications of using different measures of inflation as target variable — core inflation, CPI excluding interest rates, and headline CPI inflation. Our main results are the following. (i) Barring the interest rate component, temporary shocks to inflation do not affect optimal monetary policy under any regime. (ii) Indirect (second-round) effects of disturbances on goal variables need to be accounted for properly. Simply excluding seemingly temporary disturbances from the reaction function risks leading to inappropriate policy responses. (iii) It may be optimal to respond to changes in one measure of inflation even if the target is defined in terms of another. (iv) The presence of the direct interest rate component in the CPI tends to push optimal monetary policy in an expansionary direction. The net effect, considering also the traditional channel, however, depends on the nature of the initial disturbance.

Keywords: Inflation targeting; Underlying inflation; CPI; CPIX (search for similar items in EconPapers)
JEL-codes: E50 E52 E58 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2000-06-01
New Economics Papers: this item is included in nep-cba and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published in International Finance, 2001, pages 401-439.

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