Fighting the Inflation Caused by Foreign Price Shocks

Description

Empirical evidence indicates that the recent inflation surge in many countries stems from the rising prices of imported goods. Our project provides a framework to evaluate the monetary policy that fights inflation driven by foreign price shocks. This project has three objectives: (1) Establish a baseline framework to incorporate foreign price shocks into monetary policy analysis, which reflects the nature of the shocks as a combination of technology and markup shocks, as well as an idiosyncratic shock that transmits through open economy production networks. (2) Obtain the analytical solution of optimal monetary policy in terms of an optimal inflation targeting rule. (3) Evaluate real-time monetary policy for post-covid inflation in several countries using the optimal inflation targeting rule. We advocate a rule that depends on foreign price shocks and the nominal exchange rate. The output of this project can provide new insights into monetary policy design when foreign price shock is one of the major concerns.