Should Central Banks Target Consumer Prices or the Exchange Rate?

24 Pages Posted: 2 Jun 2006

See all articles by Tatiana Kirsanova

Tatiana Kirsanova

University of Glasgow

Campbell Leith

University of Glasgow - Department of Economics

Simon Wren-Lewis

University of Oxford - Economics Department

Abstract

In this article we consider two arguments suggesting that monetary authorities in an open economy should target output price inflation and not consumer price inflation. The first suggests that output price inflation corresponds to the distortions caused by price rigidity. The second shows how policy rules involving consumer price inflation can induce instability because of the feedback from interest rates to consumer price inflation via the exchange rate. We examine both arguments in the context of an open economy which is subject to a range of shocks. We show that both arguments remain robust but that there is a case for including a terms of trade or real exchange rate gap term in the authorities' welfare function alongside the output gap and output price inflation.

Suggested Citation

Kirsanova, Tatiana and Leith, Campbell and Wren-Lewis, Simon J.Q., Should Central Banks Target Consumer Prices or the Exchange Rate?. Economic Journal, Vol. 116, No. 512, pp. F208-F231, June 2006, Available at SSRN: https://ssrn.com/abstract=905968 or http://dx.doi.org/10.1111/j.1468-0297.2006.01097.x

Tatiana Kirsanova (Contact Author)

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

Campbell Leith

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom
++44 141 330 3702 (Phone)
++44 141 330 4940 (Fax)

Simon J.Q. Wren-Lewis

University of Oxford - Economics Department ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

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