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Practical Monetary Policies

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  • Alfred V. Guender
  • David R. Gillmore

Abstract

This paper compares a monetary policy that targets average inflation with one that targets the change in the output gap. It shows that the stabilizing properties of monetary policy strategies are sensitive to both the existence of lags in the transmission mechanism and the design of target rules. A strategy focusing on the change in the output gap is likely to prove inferior to targeting the average rate of inflation in a model where monetary policy affects the real economy sooner than inflation. Even more favourable results for average inflation targeting emerge in a framework that also includes forward-looking expectations. These results stand in marked contrast to those in standard models where policy lags are absent. To ensure sound choice of policy, central banks are advised to examine the stabilizing properties of monetary policies in a variety of models. Copyright 2010 Blackwell Publishing Ltd

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Bibliographic Info

Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 13 (2010)
Issue (Month): 1 (03)
Pages: 25-53

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Handle: RePEc:bla:intfin:v:13:y:2010:i:1:p:25-53

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  1. Athanasios Orphanides & Simon van Norden, 2002. "The Unreliability of Output-Gap Estimates in Real Time," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 569-583, November.
  2. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  3. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
  4. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  7. J. M. Culbertson, 1960. "Friedman on the Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 68, pages 617.
  8. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  9. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
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