Working Paper: CEPR ID: DP6557
Authors: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
Abstract: We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favour of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.
Keywords: exchange rate pass-through; optimal monetary policy; price discrimination; price dispersion; real exchange rates
JEL Codes: F31; F33; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| downstream nominal rigidities (D43) | upstream pricing behavior (L11) |
| stable CPI inflation volatility (E31) | reduced degree of exchange rate pass-through (F31) |
| local currency price stability of imports (F31) | influenced by nominal rigidities and strategic interactions between firms (D43) |
| lower CPI inflation volatility (E31) | lower price dispersion (L11) |
| exchange rate fluctuations (F31) | optimal monetary policy (E63) |