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Optimal Policy When the Inflation Target is not Optimal

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  • Sergio A. Lago Alves

Abstract

I assess the optimal policy to be followed by a welfare-concerned central bank when assigned an inflation target that is not necessarily welfare-optimal. I treat the inflation target as the trend inflation and I have three main contributions: (i) a welfare-based loss function fully derived under trend inflation, showing how the non-optimal inflation target acts as an extra inefficiency source; (ii) I show that the trend inflation does affect the relative weight of the output gap: they are inversely related; (iii) under trend inflation, I derive time consistent optimal policies with both unconditional and timeless commitment, and I show how to translate the pursuit of the inflation target into an additional constraint in the minimization step.

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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 271.

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Date of creation: Mar 2012
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Handle: RePEc:bcb:wpaper:271

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Web page: http://www.bcb.gov.br/?english

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  1. Camilo E Tovar, 2008. "DSGE models and central banks," BIS Working Papers 258, Bank for International Settlements.
  2. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
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  5. repec:sae:niesru:v:164:y::i:1:p:100-109 is not listed on IDEAS
  6. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
  7. Ascari, Guido & Ropele, Tiziano, 2007. "Optimal monetary policy under low trend inflation," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2568-2583, November.
  8. Sergio A. L. Alves & Waldyr D. Areosa, 2005. "Targets and Inflation Dynamics," Working Papers Series 100, Central Bank of Brazil, Research Department.
  9. Guido Ascari & Tiziano Ropele, 2009. "Trend inflation, Taylor principle and indeterminacy," Temi di discussione (Economic working papers) 708, Bank of Italy, Economic Research and International Relations Area.
  10. Olivier Coibion & Yuriy Gorodnichenko, 2010. "Monetary Policy, Trend Inflation and the Great Moderation:An Alternative Interpretation," Working Papers 94, Department of Economics, College of William and Mary.
  11. Maral Kichian & Oleksiy Kryvtsov, 2007. "Does Indexation Bias the Estimated Frequency of Price Adjustment?," Working Papers 07-15, Bank of Canada.
  12. Noah Williams & Andrew Levin & Alexei Onatski, 2005. "Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models," Computing in Economics and Finance 2005 478, Society for Computational Economics.
  13. Robert Amano & Steve Ambler & Nooman Rebei, 2007. "The Macroeconomic Effects of Nonzero Trend Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1821-1838, October.
  14. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  15. Sahuc, J-G., 2004. "Partial Indexation, Trend Inflation, and the Hybrid Phillips Curve," Working papers 118, Banque de France.
  16. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  17. Christoffel, Kai & Coenen, Günter & Warne, Anders, 2008. "The New Area-Wide Model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 0944, European Central Bank.
  18. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers 12402, National Bureau of Economic Research, Inc.
  19. Damjanovic, Tatiana & Damjanovic, Vladislav & Nolan, Charles, 2008. "Unconditionally optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 491-500, April.
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Cited by:
  1. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
  2. Guido Ascari & Argia M. Sbordone, 2013. "The macroeconomics of trend inflation," Staff Reports 628, Federal Reserve Bank of New York.
  3. Sergio A. Lago Alves, 2013. "Is the Divine Coincidence Just a Coincidence? The Implications of Trend Inflation," Working Papers Series 329, Central Bank of Brazil, Research Department.

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