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Inflation Forecast Contracts

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Abstract

We introduce a new type of incentive contract for central bankers: inflation forecast contracts, which make central bankers’ remunerations contingent on the precision of their inflation forecasts. We show that such contracts enable central bankers to influence inflation expectations more effectively, thus facilitating more successful stabilization of current inflation. Inflation forecast contracts improve the accuracy of inflation forecasts, but have adverse consequences for output. On balance, paying central bankers according to their forecasting performance improves welfare.

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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 11/149.

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Length: 24 pages
Date of creation: Jul 2011
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Handle: RePEc:eth:wpswif:11-149

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Keywords: central banks; incentive contracts; transparency; inflation targeting; inflation forecast targeting; intermediate targets;

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  1. Laubach, Thomas, 2003. "Signalling commitment with monetary and inflation targets," European Economic Review, Elsevier, vol. 47(6), pages 985-1009, December.
  2. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  3. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
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  17. Hans Gersbach & Volker Hahn, 2011. "Monetary Policy Inclinations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(8), pages 1707-1717, December.
  18. Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-20, December.
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