LAUSR

Abstract Numerous central banks ( cb s) focus on controlling the nominal interest rate (i) to sway the price level and meet the inflation target (πo) nowadays ( Taylor, 1993 , Bernanke, 1999 , Woodford, 2003 ). The i is taken to be the anchor for a low and stable rate of inflation in an open economy model. Yet, some analysts, orthodox and heterodox alike, have challenged this belief arguing that cb s turn to the exchange rate (e) channel and adopt it as a second policy tool with the aim of meeting πo ( Svensson, 1999 , Hufner, 2004 ). The purpose of this paper is to show that the veritable anchor of inflation is neither i nor e, but the wage rate and the unit labour costs ( ulc ). We conduct econometric analyses based on data from a set of inflation targeting countries. The main empirical findings support our hypothesis regarding the higher importance of wages and the ulc vis-a-vis i and e in the determination of the cpi .