The seminar will be in the Visitor Center at 3:30 pm.
Alessia Campolmi, Universitat Pompeu Fabra (MNB and CEU job candidate)
Abstract
There is common agreement on price inflation stabilization being one of the objectives of monetary policy. But, in an open economy, two alternative measures of inflation coexist: domestic inflation (DI) and consumer price inflation (CPI). Which one of the two should be the target variable? Most of the literature suggests that the monetary authority should try to stabilize DI. This is in sharp contrast with the practice of many inflation-targeting central banks which are using CPI as target variable. I use a small open economy model to show that CPI targeting can be rationalized by the presence of sticky wages indexed to past CPI. The latter assumption is highly plausible, as documented by the empirical evidence reported in, e.g., Smets and Wouters (2003).
After deriving the welfare function from a second order approximation of the utility function, I compute the fully optimal monetary policy under commitment and use it as a benchmark to compare the performance of different monetary policy rules. The rule performing best is the one targeting wage inflation and CPI. Moreover, this rule delivers results very close to those obtained under the fully optimal monetary policy with commitment.