World Food Prices and Monetary Policy
In recent years, large fluctuations in world food prices have renewed interest in the question of how monetary policy in small open economies should react to imported price shocks. We address this issue in an open economy setting similar to previous ones except that food plays a distinctive role in utility. A key novelty of our model is that the real exchange rate and the terms of trade can move in opposite directions in response to food price shocks. This has several consequences for observables and for policy. Under a variety of model calibrations, broad CPI targeting emerges as welfare-superior to alternative policy rules once the variance of food price shocks is as large as in real world data.
We thank Pietro Cova, Gian Maria Millesi-Ferretti, Bianca de Paoli, Alan Sutherland, Carlos Vegh as well as seminar participants at the Bank of Italy, IADB, IMF, PUC-RJ, the 2009 meeting of the European Econometric Society, and the 2010 World Econometric Society Congress for discussions and comments on an earlier draft. We are also grateful to Marola Castillo for excellent research assistance, to Roberto Rigobon for sharing his food expenditure database with us, and last but not least, to the Research Department of the IADB, where much of this paper was written. The opinions expressed here are, however, the authors' alone and do not necessarily reflect those of any of the above institutions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Catão, Luis A.V. & Chang, Roberto, 2015. "World food prices and monetary policy," Journal of Monetary Economics, Elsevier, vol. 75(C), pages 69-88. citation courtesy of