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The Inflation Forecast and the Loss Function

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  • Svensson, Lars E O

Abstract

This Paper argues that inflation-targeting central banks should announce explicit loss function with numerical relative weights on output-gap stabilization and use and announce optimal time-varying instrument-rate paths and corresponding inflation and output-gap forecasts. Simple voting procedures for forming the Monetary Policy Committee’s aggregate loss function and time-varying instrument-rate paths are suggested. Announcing an explicit loss function improves the transparency of inflation targeting and eliminates some misunderstandings of the meaning of ‘flexible’ inflation targeting. Using time-varying instrument-rate paths avoids a number of inconsistencies and other problems inherently associated with constant-interest-rate forecasts.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3365.

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Date of creation: May 2002
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Handle: RePEc:cpr:ceprdp:3365

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Keywords: inflation targeting; interest rate paths;

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References

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  1. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  2. Francisco Javier Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," IMF Working Papers 01/161, International Monetary Fund.
  3. Persson, T. & Tabellini, G., 1997. "Political Economics and Macroeconomic Policy," Papers 630, Stockholm - International Economic Studies.
  4. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  5. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
  6. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  7. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  8. Svensson, Lars E O & Woodford, Michael, 2004. "Implementing Optimal Policy Through Inflation-Forecast Targeting," CEPR Discussion Papers 4229, C.E.P.R. Discussion Papers.
  9. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  10. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination In Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  11. A. Robert Nobay & David A. Peel, 1998. "Optimal Monetary Policy in a Model of Asymmetric Central Bank Preferences," FMG Discussion Papers dp306, Financial Markets Group.
  12. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  13. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
  14. Sevensson, L.E.O., 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Papers 673, Stockholm - International Economic Studies.
  15. Kenneth F. Wallis, 1999. "Asymmetric density forecasts of inflation and the Bank of England's fan chart," National Institute Economic Review, National Institute of Economic and Social Research, vol. 167(1), pages 106-112, January.
  16. Charles A.E. Goodhart, 2001. "Monetary transmission lags and the formulation of the policy decision on interest rates," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 165-186.
  17. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  18. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
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Citations

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Cited by:
  1. Lars E.O. Svensson, 2005. "Targeting versus instrument rules for monetary policy: what is wrong with McCallum and Nelson?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 613-626.
  2. Daniel L. Thornton, 2003. "Monetary policy transparency: transparent about what?," Working Papers 2002-028, Federal Reserve Bank of St. Louis.
  3. Jérôme Héricourt, 2004. "And if one size fit all after all ? A counterfactual examination of the ECB monetary policy under Duisenberg presidency," Cahiers de la Maison des Sciences Economiques bla04004a, Université Panthéon-Sorbonne (Paris 1), revised Nov 2005.
  4. Lars E.O. Svensson, 2002. "Monetary Policy and Real Stabilization," Working Papers 119, Princeton University, Department of Economics, Center for Economic Policy Studies..
  5. Paolo Surico, 2003. "How does the ECB target inflation?," Macroeconomics 0305005, EconWPA.
  6. Lavan Mahadeva & Alex Muscatelli, 2005. "National Accounts Revisions and Output Gap Estimates in a Model of Monetary Policy with Data Uncertainty," Discussion Papers 14, Monetary Policy Committee Unit, Bank of England.
  7. Juan Paez-Farrell, 2009. "Timeless perspective vs discretionary policymaking when the degree of inflation persistence is unknown," Discussion Paper Series 2009_14, Department of Economics, Loughborough University, revised Sep 2009.
  8. Lars E.O. Svensson, 2003. "Monetary policy and learning," Economic Review, Federal Reserve Bank of Atlanta, issue Q3, pages 11-16.
  9. Lars E.O. Svensson, 2004. "Targeting Rules vs. Instrument Rules for Monetary Policy: What is Wrong with McCallum and Nelson?," NBER Working Papers 10747, National Bureau of Economic Research, Inc.
  10. Juillard, Michel & Karam, Philippe & Laxton, Douglas & Pesenti, Paolo, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 0613, European Central Bank.

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