The choice of the inflation rate as a target in an economy with pricing-to-market

This article verifies an effect caused by introducing alternative inflation targeting in a two-country economy model by following the new open-economy macroeconomics trend of incorporating pricing-to-market behavior among firms. Previous research suggests that, from the point of view of stabilizing output and inflation, central banks must choose producer price inflation as a target under the assumption that purchasing power parity applies. This paper, however, with a revived conventional pricing-to-market model, indicates that a central bank must choose consumer price inflation, not producer price inflation, from the point of view of stabilizing output and inflation.