Underlying Inflation in a DSGE Model

Advisor: Carlos Viana de Carvalho

We use a multi-sector sticky-price DSGE model in order to study the effects of a monetary rule that respond to changes in the underlying measure of inflation as opposed to headline inflation. The model is studied for the Australian economy, where the central bank pays significant attention to underlying inflation measures. In special, we use the model as a labotory to test the conjecture that, as the Reserve Bank of Australia started to react to the measure of underlying inflation, the deviations of headline inflation from target were less pronounced. Using a calibrated model, we don’t find evidence that the change in the monetary rule can be accounted responsible for the reduction in the volatility of inflation.