SECTORAL DIFFERENCES IN PRICE-ADJUSTMENT FREQUENCIES AND OPTIMAL MONETARY POLICY: A NOTE

This paper reconsiders the monetary policy implications of a model from which a distinction between CPI inflation and PPI inflation arises. More specifically, this paper addresses the policy conclusion by K. Huang and Z. Liu [2005, Inflation targeting: What inflation rate to target, Journal of Monetary Economics 52, 1435–1462], which states that central banks should use an optimal inflation index that gives substantial weight to stabilizing both CPI and PPI. This paper argues that these authors' findings rely on the assumption that producer prices are as sticky as consumer prices and shows that once empirically relevant frequencies of price adjustment are used to calibrate the model, CPI inflation receives substantial weight in the optimal inflation index. Moreover, this rule is remarkably robust to uncertainty regarding the model parameters.