Optimal Monetary Policy with Distinct Core and Headline Inflation Rates

48 Pages Posted: 1 Nov 2008

See all articles by Martin Bodenstein

Martin Bodenstein

Board of Governors of the Federal Reserve System

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies

Date Written: August 1, 2008

Abstract

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

Bodenstein, Martin and Erceg, Christopher J. and Guerrieri, Luca, Optimal Monetary Policy with Distinct Core and Headline Inflation Rates (August 1, 2008). FRB International Finance Discussion No. 941. Available at SSRN: https://ssrn.com/abstract=1292408 or http://dx.doi.org/10.2139/ssrn.1292408

Martin Bodenstein (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2550 (Phone)

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