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Targeting inflation in the 1990s: recent challenges

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  • Richard T. Freeman
  • Jonathan L. Willis

Abstract

This paper provides an evaluation of the effectiveness of inflation targeting in four industrial countries --New Zealand, Canada, the United Kingdom, and Sweden --focussing on the recent period of economic recovery. Evidence drawn from fmancial market data suggests that credibility of their inflation targeting regimes on balance has deteriorated during the past year and a half, as reflected mainly in sizeable increases in medium-and long-term interest rates. Even after accounting for spillovers from increases in real rates globally (which appear to have been important) and cyclical effects, recent increases in long-term interest rates appear to be incompatible with the possibility that market expectations for inflation have remained on track with official objectives. The deterioration of credibility during this period, however, is considerably less than is implied by changes in nominal interest rates alone and varies considerably across targeting countries. Other evidence suggests that, although inflation targets have not had any detectable effect in altering the time-series characteristics of nominal interest rates (and, by implication, of inflation­expectations formation), there is mixed evidence that inflation targets may have helped stabilize inflation expectations and possibly lowered the inflation-risk premium in some countries.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 525.

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Date of creation: 1995
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Handle: RePEc:fip:fedgif:525

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Related research

Keywords: Inflation (Finance) ; Interest rates ; Monetary policy;

References

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  1. Robert P. Flood & Peter Isard, 1989. "Monetary Policy Strategies," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 612-632, September.
  2. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  3. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  4. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  5. Svensson, L.E.O., 1993. "The Simplest Test of Inflation Target Credibility," Papers 560, Stockholm - International Economic Studies.
  6. Ball, Laurence, 1992. "Why does high inflation raise inflation uncertainty?," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 371-388, June.
  7. Carl E. Walsh, 1994. "Is New Zealand's Reserve Bank Act of 1989 an optimal central bank contract?," Pacific Basin Working Paper Series 94-01, Federal Reserve Bank of San Francisco.
  8. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  9. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  10. Joseph E. Gagnon & Mark D. Unferth, 1993. "Is there a world real interest rate?," International Finance Discussion Papers 454, Board of Governors of the Federal Reserve System (U.S.).
  11. Robert J. Barro, 2012. "Inflation and Economic Growth," CEMA Working Papers 568, China Economics and Management Academy, Central University of Finance and Economics.
  12. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  13. Carl E. Walsh, 2002. "When should central bankers be fired?," Economics of Governance, Springer, vol. 3(1), pages 1-21, 03.
  14. Andreas Fischer, 1993. "Inflation Targeting: The New Zealand and Canadian Cases," Cato Journal, Cato Journal, Cato Institute, vol. 13(1), pages 1-27, Spring/Su.
  15. Peter B. Clark & Douglas Laxton & David Rose, 1995. "Capacity Constraints, Inflation and the Transmission Mechanism," IMF Working Papers 95/75, International Monetary Fund.
  16. Guy Debelle, 1996. "The Ends of Three Small Inflations: Australia, New Zealand and Canada," Canadian Public Policy, University of Toronto Press, vol. 22(1), pages 56-78, March.
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Cited by:
  1. Nicholas Apergis & Stephen M. Miller & Alexandros Panethimitakis & Athanassios Vamvakidis, 2005. "Inflation Targeting and Output Growth: Evidence from Aggregate European Data," Working papers 2005-06, University of Connecticut, Department of Economics.
  2. International Monetary Fund, 2005. "Inflation Targeting and Output Growth," IMF Working Papers 05/89, International Monetary Fund.
  3. Kisu Simwaka, 2004. "The feasibility of adopting inflation targeting in Malawi: an empirical analysis," Macroeconomics 0407015, EconWPA.

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