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Defining Inflation Targets, the Policy Horizon and the Output-Inflation Tradeoff

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  • Jose De Gregorio

Abstract

This paper shows the equivalence between different approaches to defining a central bank’s inflation objective. Defining a range and the percentage of time that inflation is expected to lie within that range is the same as defining a target for projected inflation within a given horizon. Both these definitions are in turn similar to defining the target in terms of the expected value and desired variance of inflation. All these definitions are connected by the actual process of inflation. A more volatile or persistent inflation increases the policy horizon. The paper also presents evidence on how inflation targets are actually defined in many countries and compares these stated targets with that implied by the actual process of inflation. To interpret these results, the paper presents a simple model, generalized in the appendices, to show how the central bank’s tolerance of deviations from the target, as well as the policy horizon, depend on the cost of output deviations from full employment, and on the slope and degree of backward-lookingness of the Phillips curve.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 415.

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Date of creation: Mar 2007
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Handle: RePEc:chb:bcchwp:415

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  1. David Romer, 1991. "Openness and inflation: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  2. Galí, Jordi & Gambetti, Luca, 2008. "On the Sources of the Great Moderation," CEPR Discussion Papers 6632, C.E.P.R. Discussion Papers.
  3. Christopher Bowdler, 2005. "Openness, exchange rate regimes and the Phillips curve," Economics Papers 2005-W25, Economics Group, Nuffield College, University of Oxford.
  4. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  5. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  6. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  7. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  8. O'Reilly, Gerard & Whelan, Karl, 2004. "Has euro-area inflation persistence changed over time?," Working Paper Series 0335, European Central Bank.
  9. 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.
  10. repec:nbr:nberre:0126 is not listed on IDEAS
  11. de Gregorio, Jose, 1995. "Policy Accommodation and Gradual Stabilizations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 727-41, August.
  12. repec:nbr:nberwo:12876 is not listed on IDEAS
  13. Filippo Altissimo & Michael Ehrmann & Frank Smets, 2006. "Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence," Occasional Paper Series 46, European Central Bank.
  14. Perron, Pierre, 1990. "Testing for a Unit Root in a Time Series with a Changing Mean," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 153-62, April.
  15. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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