By William Barnett, Chan Wang, Xue Wang and Liyuan Wu
What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.
Thus, the monetary policy target depends on the state of the economy. To me, this sounds like having this kind of target is a bad idea, as you do not learn the state of the economy in real time. This idea of have a target was to have some real-time statistic to set policy with, after all.