Working Paper: NBER ID: w16563
Authors: Luis Cato; Roberto Chang
Abstract: In recent years, large fluctuations in world food prices have renewed interest in the question of how monetary policy in small open economies should react to imported price shocks. We address this issue in an open economy setting similar to previous ones except that food plays a distinctive role in utility. A key novelty of our model is that the real exchange rate and the terms of trade can move in opposite directions in response to food price shocks. This has several consequences for observables and for policy. Under a variety of model calibrations, broad CPI targeting emerges as welfare-superior to alternative policy rules once the variance of food price shocks is as large as in real world data.
Keywords: Food Prices; Monetary Policy; Small Open Economies; CPI Targeting; PPI Targeting
JEL Codes: E5; E6; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| food price shocks (Q11) | inflation rates (E31) |
| food price shocks (Q11) | deviations from central inflation targets (E31) |
| CPI targeting (E31) | welfare outcomes (I38) |
| food price shocks (Q11) | RER and TOT moving in opposite directions (R39) |
| food prices (Q11) | global inflation (E31) |