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Aiming for the Bull's Eye: Inflation Targeting under Uncertainty

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  • M. Demertzis
  • N. Viegi

Abstract

We study the implications of uncertainty for ination targeting. We apply Brainard's static framework which imposes multiplicative uncertainty in the monetary transmission. Brainard's main result is that in the presence of uncertainty, monetary authorities become naturally more cautious. But this also implies that monetary objectives are seldom achieved. We there- fore attempt next to ...nd a monetary rule that reaches the objectives set more often, improving therefore the welfare of the Central Bank. Such a rule is the result of a new algorithm that we put forward, in which the ination target is state contigent. The Central Bank sets (as an auxil- liary step) therefore, a variable ination target that depends optimally, on both the degree of uncertainty as well as on the shocks that occur each time. We show that such a rule helps the CB attain its objectives more often thereby reducing the losses incurred. Moreover, and as a corollary to such an approach, the rule derived is ex ante neutral to the degree of uncertainty.

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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 88.

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Length: 18 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:dnb:staffs:88

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Keywords: Ination Targeting; Uncertainty; Variable Target; Transparency;

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References

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  1. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  2. Geraats, Petra M, 2000. "Why Adopt Transparency? The Publication of Central Bank Forecasts," CEPR Discussion Papers 2582, C.E.P.R. Discussion Papers.
  3. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August.
  4. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-97, May.
  5. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
  6. Hughes Hallett, Andrew J, 1989. "Econometrics and the Theory of Economic Policy: The Tinbergen-Theil Contributions 40 Years On," Oxford Economic Papers, Oxford University Press, vol. 41(1), pages 189-214, January.
  7. Glenn D. Rudebusch & Carl E. Walsh, 1998. "U.S. inflation targeting: pro and con," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may29.
  8. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
  9. Lewis, Karen K, 1991. "Why Doesn't Society Minimize Central Bank Secrecy?," Economic Inquiry, Western Economic Association International, vol. 29(3), pages 403-15, July.
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Citations

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Cited by:
  1. Maria Demertzis & Nicola Viegi, 2005. "Inflation Targets as Focal Points," Money Macro and Finance (MMF) Research Group Conference 2005 52, Money Macro and Finance Research Group.
  2. Maria Demertzis & Nicola Viegi, 2004. "The Dynamic Properties of Inflation Targeting Under Uncertainty," DNB Staff Reports (discontinued) 113, Netherlands Central Bank.
  3. Giuseppe Ciccarone & Giovanni Di Bartolomeo & Enrico Marchetti, 2005. "Supply- side Fiscal Policy,Conservativeness, and Central Bank trasparency," Working Papers 77, University of Rome La Sapienza, Department of Public Economics.

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