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Inflation Targets as Focal Points

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Author Info
Maria Demertzis (De Nederlandsche Bank and University of Amsterdam)
Nicola Viegi (University of Cape Town and ERSA)

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Abstract

In a world characterized by noisy information and conflicting signals, no central bank is able to affect private-sector expectations at all times. In order to evaluate the effectiveness of any central bank communication strategy, it is important to know what private agents rely on when they form expectations. We model monetary policy as an information game in which individuals form their expectations based on all the information that is available to them (public and private) and are, therefore, subject to the noise that characterizes that information. Individual agents also know that inflation is ultimately affected both by central bank policies and by the average expectation formed by all agents. The way individuals interpret these two components to form their expectations is explained in the context of a higher-order expectations setup and is central to our argument. We then apply Bacharach's (1993) variable-universe methodology to provide a framework for assessing everyone’s interpretations. Therefore, our contribution is, first, to describe monetary policy as an information game in which interpretations matter and, second, to provide a way of solving for these interpretations. We show that a monetary policy regime that has explicit quantitative objectives may provide individuals with better anchors for coordinating their expectations. However, that is only true either if no great shocks are anticipated or if all other public information is very unclear, leaving the inflation target as the only clear piece of information available. We derive the conditions under which this is true.

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Publisher Info
Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 1 (March)
Pages: 55-87
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Handle: RePEc:ijc:ijcjou:y:2008:q:1:a:2

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Find related papers by JEL classification:
C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December. [Downloadable!] (restricted)
  2. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One decade of inflation targeting in the world : What do we know and what do we need to know?," Working Papers Central Bank of Chile 101, Central Bank of Chile. [Downloadable!]
    Other versions:
  3. Christopher R. Knittel & Victor Stango, 2003. "Price Ceilings as Focal Points for Tacit Collusion: Evidence from Credit Cards," American Economic Review, American Economic Association, vol. 93(5), pages 1703-1729, December. [Downloadable!] (restricted)
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  4. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June. [Downloadable!] (restricted)
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  5. Fatás, Antonio & Mihov, Ilian & Rose, Andrew K, 2004. "Quantitative Goals for Monetary Policy," CEPR Discussion Papers 4445, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  7. Kenneth N. Kuttner, 2004. "The role of policy rules in inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 89-112. [Downloadable!]
  8. Andrew T. Levin & Fabio M. Natalucci & Jeremy M. Piger, 2004. "The macroeconomic effects of inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 51-80. [Downloadable!]
  9. Jeffrey D. Amado & Stephen Morris & Hyun Song Shin, 2003. "Communication and Monetary Policy," Cowles Foundation Discussion Papers 1405, Cowles Foundation, Yale University. [Downloadable!]
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  10. Sugden, Robert, 1995. "A Theory of Focal Points," Economic Journal, Royal Economic Society, vol. 105(430), pages 533-50, May. [Downloadable!] (restricted)
  11. George-Marios Angeletos & Alessandro Pavan, 2007. "Efficient Use of Information and Social Value of Information," Econometrica, Econometric Society, vol. 75(4), pages 1103-1142, 07. [Downloadable!] (restricted)
  12. Jeffery Amato & Hyun Song Shin, 2003. "Public and Private Information in Monetary Policy Models," Levine's Bibliography 666156000000000092, UCLA Department of Economics. [Downloadable!]
  13. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Stephen Morris & Hyun S Shin, 2001. "Global Games: Theory and Applications," Levine's Working Paper Archive 122247000000001080, UCLA Department of Economics. [Downloadable!]
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  16. M. Demertzis & N. Viegi, 2004. "Aiming for the Bull's Eye: Inflation Targeting under Uncertainty," DNB Staff Reports (discontinued) 88, Netherlands Central Bank. [Downloadable!]
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  17. Canzoneri, Matthew B, 1985. "Monetary Policy Games and the Role of Private Information," American Economic Review, American Economic Association, vol. 75(5), pages 1056-70, December. [Downloadable!] (restricted)
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  18. Casajus, Andre, 2000. "Focal Points in Framed Strategic Forms," Games and Economic Behavior, Elsevier, vol. 32(2), pages 263-291, August. [Downloadable!] (restricted)
  19. John C. Williams & Athanasios Orphanides, 2004. "The Decline of Activist Stabilization Policy: Natural Rate Misperceptions, Learning, and Expectations," Computing in Economics and Finance 2004 144, Society for Computational Economics. [Downloadable!]
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  20. Bomfim, Antulio N & Rudebusch, Glenn D, 2000. "Opportunistic and Deliberate Disinflation under Imperfect Credibility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 707-21, November.
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  21. Hyun Song Shin & Jeffery D. Amato, 2003. "Public and private information in monetary policy models," BIS Working Papers 138, Bank for International Settlements. [Downloadable!]
  22. Jon Faust & Dale W. Henderson, 2004. "Is inflation targeting best-practice monetary policy?," International Finance Discussion Papers 807, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  24. Johnson, David R., 2002. "The effect of inflation targeting on the behavior of expected inflation: evidence from an 11 country panel," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1521-1538, November. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Maria Demertzis & Marco Hoeberichts, 2006. "The Costs of Increasing Transparency," DNB Working Papers 080, Netherlands Central Bank, Research Department. [Downloadable!]
  2. Eijffinger, Sylvester C W & van der Cruijsen, Carin A B, 2007. "The Economic Impact of Central Bank Transparency: A Survey," CEPR Discussion Papers 6070, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Bayangos, V.B., 2006. "Exchange rate uncertainty and monetary transmission in the Philippines," Working Papers - General Series 434, Institute of Social Studies. [Downloadable!]
  4. Maria Demertzis, 2006. "The role of expectations in monetary policy," DNB Working Papers 118, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
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