TY - JOUR AU - Corsetti, Giancarlo AU - Dedola, Luca AU - Leduc, Sylvain TI - Optimal Monetary Policy and the Sources of Local-Currency Price Stability JF - National Bureau of Economic Research Working Paper Series VL - No. 13544 PY - 2007 Y2 - October 2007 DO - 10.3386/w13544 UR - http://www.nber.org/papers/w13544 L1 - http://www.nber.org/papers/w13544.pdf N1 - Author contact info: Giancarlo Corsetti Faculty of Economics Cambridge University Sidgwick Avenue CB3 9DD Cambridge, Cambs United Kingdom Tel: +44(0)1223335235 E-Mail: giancarlo.corsetti@gmail.com Luca Dedola DG Research Postfach 16 03 19 D- 60066 Frankfurt am Main GERMANY Europe E-Mail: luca.dedola@ecb.int Sylvain Leduc Federal Reserve Bank of San Francisco 101 Market St. San Francisco, CA 94105 Tel: 4159743059 Fax: 4159742168 E-Mail: sylvain.leduc@sf.frb.org M1 - published as Giancarlo Corsetti, Luca Dedola, Sylvain Leduc. "Optimal Monetary Policy and the Sources of Local-Currency Price Stability," in Jordi Galí and Mark J. Gertler, editors, "International Dimensions of Monetary Policy " University of Chicago Press (2009) M3 - presented at "International Dimensions of Monetary Policy Conf.", June 11-13, 2007 AB - We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favor of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods. ER -