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Forecast-based monetary policy

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Author Info

  • Thomas Laubach

    (Federal Reserve Board)

  • Jeffery D. Amato

    (Goldman Sachs International)

Abstract

This article analyses the welfare consequences of delegating to the central bank the task of minimising deviations of forecasts of goal variables from their target values. The delegated objectives considered in this article are motivated by the observation that central banks oftentimes operate under objectives which do not necessarily represent society's preferences. The analysis is performed using an estimated model of optimising households and firms that generates tradeoffs between stabilising wage and price inflation and the output gap. We find that when the central bank's objective is defined solely in terms of price inflation, it is welfare optimal to stabilise only those fluctuations in price inflation that are forecastable at least five quarters ahead. On the other hand, when the central bank's objective involves both wage and price inflation stabilisation, the central bank should stabilise all fluctuations in these variables, not just those forecastable at some horizon.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 89.

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Length: 40 pages
Date of creation: Aug 2000
Date of revision:
Handle: RePEc:bis:biswps:89

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References

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  1. 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.
  2. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers 590, Board of Governors of the Federal Reserve System (U.S.).
  3. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  4. Jeffery D. Amato & Thomas Laubach, 1999. "Monetary policy in an estimated optimization-based model with sticky prices and wages," Research Working Paper 99-09, Federal Reserve Bank of Kansas City.
  5. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  6. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  7. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  8. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  9. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  10. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  11. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  12. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  13. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  14. Michael Woodford, 2001. "Inflation Stabilization and Welfare," NBER Working Papers 8071, National Bureau of Economic Research, Inc.
  15. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  16. 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.
  17. 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.
  18. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, August.
  19. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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Cited by:
  1. Per Jansson & Anders Vredin, 2001. "Forecast-based monetary policy in Sweden 1992-98: a view from within," BIS Papers chapters, in: Bank for International Settlements (ed.), Empirical studies of structural changes and inflation, volume 3, pages 204-226 Bank for International Settlements.
  2. Lance J. Bachmeier & Norman R. Swanson, 2005. "Predicting Inflation: Does The Quantity Theory Help?," Economic Inquiry, Western Economic Association International, vol. 43(3), pages 570-585, July.
  3. Athanasios Orphanides, 2001. "Monetary policy rules, macroeconomic stability and inflation: a view from the trenches," Working Paper Series 115, European Central Bank.
  4. Jansson, Per & Vredin, Anders, 2001. "Forecast-based Monetary Policy in Sweden 1992-1998: A View from Within," Working Paper Series 120, Sveriges Riksbank (Central Bank of Sweden).
  5. Frank Smets, 2000. "What horizon for price stability," Working Paper Series 24, European Central Bank.

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