Inflation Targeting - a Framework for Communication
AbstractMore than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being �successful'. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 149.
Date of creation: Oct 2007
Date of revision:
Monetary Policy; Communication; Focal Points; Credibility; Optimal Band-Width.;
Other versions of this item:
- Demertzis Maria & Viegi Nicola, 2009. "Inflation Targeting: A Framework for Communication," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-32, December.
- Maria Demertzis & Nicola Viegi, 2008. "Inflation Targeting: a Framework for Communication," Working Papers 71, Economic Research Southern Africa.
- C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
- C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-11-17 (All new papers)
- NEP-CBA-2007-11-17 (Central Banking)
- NEP-MAC-2007-11-17 (Macroeconomics)
- NEP-MON-2007-11-17 (Monetary Economics)
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- Isabelle SALLE (GREThA, CNRS, UMR 5113) & Murat YILDIZOGLU (GREThA, CNRS, UMR 5113) & Marc-Alexandre SENEGAS (GREThA, CNRS, UMR 5113), 2012. "Inflation targeting in a learning economy: An ABM perspective," Cahiers du GREThA 2012-15, Groupe de Recherche en Economie Théorique et Appliquée.
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- Cheick Kader M'baye, 2012. "Inflation Targeting under Heterogeneous Information and Sticky Prices," Working Papers 1202, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
- Gabriele Galati & John Lewis & Steven Poelhekke & Chen Zhou, 2011. "Have market views on the sustainability of fiscal burdens influenced monetary authorities' credibility?," DNB Working Papers 304, Netherlands Central Bank, Research Department.
- Isabelle SALLE & Marc-Alexandre SENEGAS & Murat YILDIZOGLU, 2013. "How Transparent About Its Inflation Target Should a Central Bank be? An Agent-Based Model Assessment," Cahiers du GREThA 2013-24, Groupe de Recherche en Economie Théorique et Appliquée.
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