Optimal Monetary Policy with Distinct Core and Headline Inflation Rates
48 Pages Posted: 1 Nov 2008
Date Written: August 1, 2008
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: Energy-price shocks, monetary policy tradeoffs, DSGE models
JEL Classification: E32
Suggested Citation: Suggested Citation