Has Asian Emerging Market Monetary Policy Been Too Procyclical When Responding to Swings in Commodity Prices?

Commodity price fluctuations in recent years have led to wide swings in inflationary pressures across Asian emerging market economies and have revived the discussion on how monetary policy should best react. We argue that the conventional wisdom for emerging market economies of treating commodity price fluctuations as external supply shocks is misguided in the current policy environment. We first present new empirical evidence that global demand shocks have driven commodity prices and inflationary pressures in Asian economies. We then show that the incorrect diagnosis of global demand shocks as external supply shocks leads to suboptimal outcomes in a simple two-country monetary policy model with endogenously determined commodity prices. Given such misdiagnosis risk, the results in this paper strengthen the case for targeting headline inflation as part of a robust monetary policy framework for Asian emerging market economies.Full publication: "http://ssrn.com/abstract=2420025" Globalisation, Inflation and Monetary Policy in Asia and the Pacific