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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. Peter J. Klenow & Benjamin A. Malin, 2010. "Microeconomic Evidence on Price-Setting," NBER Working Papers 15826, National Bureau of Economic Research, Inc.
  2. 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.
  3. Maral Kichian & Oleksiy Kryvtsov, 2007. "Does Indexation Bias the Estimated Frequency of Price Adjustment?," Working Papers 07-15, Bank of Canada.
  4. Robert Amano & Steve Ambler & Nooman Rebei, 2006. "The Macroeconomic Effects of Non-Zero Trend Inflation," Working Papers 06-34, Bank of Canada.
  5. Guido Ascari & Tiziano Ropele, 2009. "Trend Inflation, Taylor Principle and Indeterminacy," Quaderni di Dipartimento 097, University of Pavia, Department of Economics and Quantitative Methods.
  6. 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.
  7. Damjanovic, Tatiana & Damjanovic, Vladislav & Nolan, Charles, 2008. "Unconditionally optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 491-500, April.
  8. 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.
  9. 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.
  10. Olivier Coibion & Yuriy Gorodnichenko, 2008. "Monetary Policy, Trend Inflation and the Great Moderation: An Alternative Interpretation," NBER Working Papers 14621, National Bureau of Economic Research, Inc.
  11. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Paper Series 2005-15, Federal Reserve Bank of San Francisco.
  12. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  13. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
  14. Tovar, Camilo Ernesto, 2009. "DSGE Models and Central Banks," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(16), pages 1-31.
  15. Ascari, Guido & Ropele, Tiziano, 2007. "Optimal monetary policy under low trend inflation," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2568-2583, November.
  16. Sergio A. L. Alves & Waldyr D. Areosa, 2005. "Targets and Inflation Dynamics," Working Papers Series 100, Central Bank of Brazil, Research Department.
  17. Sahuc, Jean-Guillaume, 2006. "Partial indexation, trend inflation, and the hybrid Phillips curve," Economics Letters, Elsevier, vol. 90(1), pages 42-50, January.
  18. repec:sae:niesru:v:164:y::i:1:p:100-109 is not listed on IDEAS
  19. 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.
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Cited by:
  1. 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.
  2. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
  3. Guido Ascari & Argia M. Sbordone, 2013. "The Macroeconomics of Trend Inflation," DEM Working Papers Series 053, University of Pavia, Department of Economics and Management.

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