The UK’s monetary policy strategy is one of floating exchange rates and inflation forecast targeting,

with the targeted measure referring to consumer prices. We consider whether it is welfare-reducing

to target inflation in the CPI rather than in a narrower index and the role of the exchange rate in the

transmission of monetary policy actions to CPI inflation. It is appropriate to model imports as

intermediate goods rather than goods consumed directly by households. This leads to a simpler

transmission mechanism of monetary policy while also offering a sustainable explanation of the

weakness of the exchange rate/inflation relationship and making consumer price inflation an

appropriate monetary policy target.