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Open-Economy Inflation-Forecast Targeting

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  • Kai Leitemo

Abstract

We study simple inflation-forecast targeting in an open-economy setting. Simple inflation-forecast targeting implies setting an interest rate which, if kept unchanged throughout the forecast-targeting horizon, produces a conditional inflation forecast equal to the inflation target at the end of the horizon. We find that the optimal forecast-targeting horizon is relatively short (one year). A longer horizon does not consistently contribute to improved output stability, indeed it increases exchange rate variability and traded sector variability. The targeting procedure is substantially inferior to the optimal pre-commitment policy. Moreover, the targeting procedure does not necessarily determine the rational-expectations equilibrium and is subject to time inconsistency. Copyright Verein für Socialpolitik and Blackwell Publishing Ltd. 2006.

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Bibliographic Info

Article provided by Verein für Socialpolitik in its journal German Economic Review.

Volume (Year): 7 (2006)
Issue (Month): (02)
Pages: 35-64

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Handle: RePEc:bla:germec:v:7:y:2006:i::p:35-64

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References

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  1. Andrew P. Blake and Peter F. Westaway, . "Credibility and the effectiveness of inflation targeting regimes," NIESR Discussion Papers 85, National Institute of Economic and Social Research.
  2. Pierre-Yves HENIN & Marie PODEVIN, 2002. "Assessing the Effects of Policy Changes: Lesson from the European 1992 Experience," Annales d'Economie et de Statistique, ENSAE, issue 67-68, pages 435-461.
  3. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  4. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  5. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  6. Kai Leitemo, 2004. "Targeting Inflation by Forecast Feedback Rules in Small Open Economies," Computing in Economics and Finance 2004 18, Society for Computational Economics.
  7. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  8. Leitemo, Kai & Söderström, Ulf, 2001. "Simple Monetary Policy Rules and Exchange Rate Uncertainty," Working Paper Series 122, Sveriges Riksbank (Central Bank of Sweden).
  9. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
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Citations

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Cited by:
  1. Argov, Eyal & Elkayam, David, 2007. "An Estimated New Keynesian Model for Israel," MPRA Paper 9412, University Library of Munich, Germany.
  2. Argov, Eyal & Binyamini, Alon & Elkayam, David & Rozenshtrom, Irit, 2007. "A Small Macroeconomic Model to Support Inflation Targeting in Israel," MPRA Paper 4784, University Library of Munich, Germany.
  3. Magdalena Szyszko, 2011. "The interdependences of central bank’s forecasts and economic agents inflation expectations.Empirical study," National Bank of Poland Working Papers 105, National Bank of Poland, Economic Institute.
  4. Sánchez, Marcelo, 2005. "The link between interest rates and exchange rates: do contractionary depreciations make a difference?," Working Paper Series 0548, European Central Bank.
  5. Leitemo, Kai, 2006. "Targeting inflation by forecast feedback rules in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 30(3), pages 393-413, March.
  6. Franz Seitz & Karl-Heinz Tödter, 2001. "How the P* Model Rationalizes Monetary Targeting: A Comment on Svensson," German Economic Review, Verein für Socialpolitik, vol. 2(3), pages 303-308, 08.

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