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What inflation measure should a currency union target?

Author

Listed:
  • William A. Barnett

    (Department of Economics, University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin)

  • Chan Wang

    (School of Finance, Central University of Finance and Economics, Beijing, China)

  • Xue Wang

    (Department of Finance, Jinan University, Guangzhou, China)

  • Liyuan Wu

    (Guanghua School of Management, Peking University, Beijing, China)

Abstract
What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.

Suggested Citation

  • William A. Barnett & Chan Wang & Xue Wang & Liyuan Wu, 2018. "What inflation measure should a currency union target?," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 201805, University of Kansas, Department of Economics, revised May 2018.
    • Handle: RePEc:kan:wpaper:201805
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    File URL: http://www2.ku.edu/~kuwpaper/2018Papers/201805.pdf
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    References listed on IDEAS

    as
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. What inflation measure should a currency union target?
      by Christian Zimmermann in NEP-DGE blog on 2018-10-29 03:33:35

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    More about this item

    Keywords

    Core inflation; Headline inflation; Optimal monetary policy; Currency union; Welfare.;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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