Monetary Policy Design when Consumption Prices are Subsidized: The Case of Tunisia

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Several theoretical studies suggest that price inflation targeting is the right design for a monetary policy. Experiences of several countries that adopted the policy in the 1990s motivate this result. The countries particularly attained substantial decline in output, inflation, and interest rate fluctuations. Many other states are adopting this monetary regime, including emerging markets and developing countries. This is despite their historical and economic differences. Indeed, the countries face different market imperfections and government interventions in setting prices or quantities in some markets. This paper uses structural general-equilibrium approach with price rigidity to test the premise that inflation targeting improves welfare, taking into consideration an environment where the government subsidises a share of private consumption expenditures.

Our approach involves estimating a dynamic stochastic general-equilibrium model for Tunisia. A second order approximation of the model is applied to compare several Taylor Rule’s specifications based on different definitions of inflation rates (CPI and sectoral price indices).