Sustainable Real Exchange Rates in the New EU Member States: What did the Great Recession Change? PDF (Adobe DRM) download by Jan Babecky

Sustainable Real Exchange Rates in the New EU Member States: What did the Great Recession Change?

INTERNATIONAL MONETARY FUND
Publication date: August 2006
ISBN: 9781455205288
Digital Book format: PDF (Adobe DRM)

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In models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We develop a two-sector two-good new-Keynesian model to study the optimal choice of price index in markets with financial frictions. We find that, in the presence of financial frictions, a welfare-maximizing central bank should adopt flexible headline inflation targeting a target for headline CPI inflation with some weight on the output gap. These results are particularly relevant for emerging markets, where the share of food expenditures in total consumption expenditures is high and a large proportion of consumers are credit constrained.
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