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Inflation Target Transparency and the Macroeconomy

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Author Info
Martin Melecky
Diego Rodríguez Palenzuela
Ulf Söderström

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Abstract

We quantify the effects of monetary policy transparency and credibility on macroeconomic volatility in an estimated model of the Eurozone. In our model, private agents are unable to distinguish between temporary shocks to the central bank's monetary policy rule and persistent shifts in the inflation target, and therefore use optimal filtering techniques to construct estimates of the future monetary policy stance. We find that the macroeconomic benefits of credibly announcing the current level of the time-varying inflation target are reasonably small as long as private agents correctly understand the stochastic processes governing the inflation target and the temporary policy shock. If, on the other hand, private agents overestimate the volatility of the inflation target, the overall gains of announcing the target can be substantial. We also show that the central bank can, to some extent, help private agents in their learning process by responding more aggressively to deviations of inflation from the target.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 490.

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Date of creation: Oct 2008
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Handle: RePEc:chb:bcchwp:490

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  1. Fève,P. & Materon,J. & Sahuc, J-G., 2009. "Inflation Target Shocks and Monetary Policy Inertia in the Euro Area," Documents de Travail 243, Banque de France. [Downloadable!]
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