World food prices and monetary policy

Luis A.V. Catão, Roberto Chang

Research output: Contribution to journalArticlepeer-review

23 Scopus citations

Abstract

How should monetary policy respond to large fluctuations in world food prices? We study this question in an open economy model in which imported food has a larger weight in domestic consumption than abroad and international risk sharing can be imperfect. A key novelty is that the real exchange rate and the terms of trade can move in opposite directions in response to world food price shocks. This exacerbates the policy trade-off between stabilizing output prices vis a vis the real exchange rate, to an extent that depends on risk sharing and the price elasticity of exports. We characterize implications for dynamics, optimal monetary policy, and the relative performance of practical monetary rules. While CPI targeting and expected CPI targeting can dominate PPI targeting if international risk sharing is perfect, even seemingly mild departures from the latter make PPI targeting a winner.

Original languageEnglish (US)
Pages (from-to)69-88
Number of pages20
JournalJournal of Monetary Economics
Volume75
DOIs
StatePublished - Oct 2015

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Keywords

  • Monetary policy
  • Real exchange rates
  • Small open economy
  • Terms of trade

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