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Oxford Economic Papers Advance Access originally published online on December 10, 2004
Oxford Economic Papers 2005 57(1):1-33; doi:10.1093/oep/gpi008
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Right arrow E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution
Right arrow E52 - Monetary Policy (Targets, Instruments, and Effects)
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© Oxford University Press 2004; All rights reserved

Cost-push shocks and monetary policy in open economies

Alan Sutherland

Department of Economics, University of St Andrews, St. Andrews, Fife, KY16 9AL; and CEPR; e-mail: ajs10{at}st-and.ac.uk

This paper analyses the implications of cost-push shocks for the optimal choice of monetary policy target in a two-country sticky-price model. In addition to cost-push shocks, each country is subject to labour-supply and money-demand shocks. It is shown that the fully optimal coordinated policy can be supported by independent national monetary authorities following a policy of flexible inflation targeting. A number of simple (but non-optimal) targeting rules are compared. Strict producer-price targeting is found to be the best simple rule when the variance of cost-push shocks is small. Strict consumer-price targeting is best for intermediate levels of the variance of cost-push shocks. And nominal-income targeting is best when the variance of cost-push shocks is high. In general, money-supply targeting and fixed nominal exchange rates are found to yield less welfare than these other regimes.

Key Words: JEL classifications: E52 • E58 • F41


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