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Credible Disinflation Policy in a Dynamic Setting

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Author Info

  • Christopher F. Baum

    ()
    (Boston College)

  • Meral Karasulu

    ()
    (Bogazici University)

Abstract

This paper builds upon the analysis of Orphanides and Wilcox (1996) to evaluate optimal anti-inflation policy under a broader set of circumstances than considered in their work. We consider a monetary authority with two instruments--the funds rate and the discount rate--with the distinction that only movements of the latter are 'credible' alterations of the Fed's policy stance, reflecting reputational effects. The public forms expectations of inflation given realized inflation and the expected progress toward lower inflation, as evidenced by credible policy moves. Optimal policy is formulated in a stochastic, dynamic setting of the Tinbergen-Theil framework. The presence of a "cost-of-change" penalty on the sequence of discount rate adjustments generates expected trajectories for targets and policy instruments which differ considerably from those lacking such a penalty.

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File URL: http://fmwww.bc.edu/EC-P/wp375.pdf
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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 375.

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Length: 36 pages
Date of creation: 01 Jun 1997
Date of revision:
Handle: RePEc:boc:bocoec:375

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Related research

Keywords: disinflation; credibility; optimal policy design;

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References

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  1. Baum, Christopher F & Karasulu, Meral, 1998. "Modelling Federal Reserve Discount Policy," Computational Economics, Society for Computational Economics, vol. 11(1-2), pages 53-70, April.
  2. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  3. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.).
  4. Kozicki, Sharon & Tinsley, P A, 1998. "Moving Endpoints and the Internal Consistency of Agents' Ex Ante Forecasts," Computational Economics, Society for Computational Economics, vol. 11(1-2), pages 21-40, April.
  5. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
  6. Aksoy, Yunus & Orphanides, Athanasios & Small, David & Wieland, Volker & Wilcox, David, 2006. "A quantitative exploration of the opportunistic approach to disinflation," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1877-1893, November.
  7. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  8. Roszbach, Kasper, 1997. "Reaction Function Estimation when Central Banks Face Adjustment Costs," Working Paper Series in Economics and Finance 155, Stockholm School of Economics.
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