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Does Inflation Targeting Increase Output volatility? An International Comparison of Policy Maker's Preferences and Outcomes

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Stephen Cecchetti
Michael Ehrmann

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Abstract

Aggregate shocks that move output and inflation in opposite directions create a tradeoff between output and inflation variability, forcing central bankers to make a choice. Differences in the degree of accommodation of shocks lead to disparate variability outcomes, revealing national central banker's relative weight on output and inflation variability in their preferences. We use estimates of the structure of 23 industrialized and developing economies, including 9 that target inflation explicitly, together with the realized output and inflation patterns in those countries, to infer the degree of policymakers' inflation variability aversion. Our results suggest that both countries that introduced inflation targeting, and non-targeting European Union countries approaching monetary union, increased their revealed aversion to inflation variability, and likely suffered most increases in output volatility as a result.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 69.

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Date of creation: Apr 2000
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Handle: RePEc:chb:bcchwp:69

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  1. Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14. [Downloadable!]
  2. Michael Ehrmann, 2000. "Comparing monetary policy transmission across European countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 136(1), pages 58-83, March. [Downloadable!] (restricted)
  3. King, Robert G. & Plosser, Charles I. & Stock, James H. & Watson, Mark W., 1991. "Stochastic Trends and Economic Fluctuations," American Economic Review, American Economic Association, vol. 81(4), pages 819-40, September. [Downloadable!] (restricted)
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  4. 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. [Downloadable!] (restricted)
  5. Warne, A., 1993. "A Common Trends Model: Identification, Estimation and Inference," Papers 555, Stockholm - International Economic Studies.
  6. Cecchetti, Stephen G & McConnell, Margaret M & Perez-Quiros, Gabriel, 2002. "Policymakers' Revealed Preferences and the Output-Inflation Variability Trade-Off: Implications for the European System of Central Banks," Manchester School, University of Manchester, vol. 70(4), pages 596-618, Special I. [Downloadable!] (restricted)
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