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What Measure of Inflation Should a Developing Country Central Bank Target?

38 Pages Posted: 27 Nov 2015  

Rahul Anand

International Monetary Fund (IMF)

Eswar S. Prasad

Cornell University - Dyson School of Applied Economics and Management; Cornell University - Department of Economics; Brookings Institution; NBER; IZA Institute of Labor Economics

Boyang Zhang

Cornell University, Department of Economics, Students

Multiple version iconThere are 3 versions of this paper

Date Written: September 2015

Abstract

In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We analyze this result in the context of developing economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. We develop an open economy model with incomplete financial markets to show that headline inflation targeting improves welfare outcomes. We also compute the optimal price index, which includes a positive weight on food prices but, unlike headline inflation, assigns zero weight to import prices.

Keywords: monetary policy framework, core inflation, headline inflation, financial frictions, inflation, economies, welfare, Monetary Policy (Targets, Instruments, and Effects),

JEL Classification: E31, E31, E52, E52, E61, E61

Suggested Citation

Anand, Rahul and Prasad, Eswar S. and Zhang, Boyang, What Measure of Inflation Should a Developing Country Central Bank Target? (September 2015). IMF Working Paper No. 15/205. Available at SSRN: https://ssrn.com/abstract=2696063

Rahul Anand (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Eswar S. Prasad

Cornell University - Dyson School of Applied Economics and Management ( email )

440 Warren Hall
Ithaca, NY 14853
United States

HOME PAGE: http://prasad.aem.cornell.edu

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

Brookings Institution ( email )

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Boyang Zhang

Cornell University, Department of Economics, Students ( email )

Ithaca, NY
United States

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