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The inflation bias revisited: theory and some international evidence

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  • Alex Cukierman
  • Stefan Gerlach

Abstract

The Kydland-Prescott, Barro-Gordon inflation bias result relies on the presumption that policymakers aim at achieving a level of employment above potential. Both academics and policymakers have recently questioned this presumption on the ground of realism. We show that even if policymakers are content with the normal level of employment there is an inflation bias if the central bank is uncertain about the future state of the economy, and is more sensitive to policy misses leading to employment below the normal level than to policy misses leading to employment above it. This new view of the inflation bias implies that there should be a positive association between average inflation and the variance of shocks to output. Cross sectional empirical evidence from 21 developed economies supports this implication. The Paper also discusses the consequences for the transparency of monetary policy and for central bank reform.

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Bibliographic Info

Article provided by University of Manchester in its journal The Manchester School.

Volume (Year): 71 (2003)
Issue (Month): 5 (09)
Pages: 541-565

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Handle: RePEc:bla:manchs:v:71:y:2003:i:5:p:541-565

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References

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  1. Lars E.O. Svensson, 1997. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  2. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  4. Torsten Persson & Guido Tabellini, . "Political Economics and Macroeconomic Policy," Working Papers 121, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  6. Svensson, Lars E.O., 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Seminar Papers 615, Stockholm University, Institute for International Economic Studies.
  7. Alex Cukierman & V. Anton Muscatelli, 2002. "Do Central Banks have Precautionary Demands for Expansions and for Price Stability? - Theory and Evidence," CESifo Working Paper Series 764, CESifo Group Munich.
  8. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
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  10. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 195-225.
  11. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  12. Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
  13. Douglas O. Staiger & James H. Stock & Mark W. Watson, 1997. "How Precise Are Estimates of the Natural Rate of Unemployment?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 195-246 National Bureau of Economic Research, Inc.
  14. Alex Cukierman, 2002. "Are contemporary central banks transparent about economic models and objectives and what difference does it make?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 15-36.
  15. Cukierman, A., 1996. "The Economics of Central Banking," Discussion Paper 1996-31, Tilburg University, Center for Economic Research.
  16. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  17. Alex Cukierman & Anton Muscatelli, 2001. "Do Central Banks have Precautionary Demands for Expansions and for Price Stability?," Working Papers 2002_4, Business School - Economics, University of Glasgow, revised Mar 2002.
  18. Vickers, John, 1986. "Signalling in a Model of Monetary Policy with Incomplete Information," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 443-55, November.
  19. Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, May.
  20. 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.
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