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Inflation targeting: why it works and how to make it work better

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  • William T. Gavin

Abstract

Inflation targeting has worked so well because it leads policymakers to debate, decide on, and communicate the inflation objective. In practice, this process has led the public to believe that the central bank has a long-term inflation objective. Inflation targeting has been successful, then, because the central bank decides on an objective and announces it, not because of a change in its day-to-day behavior in money markets or the way it reacts to news about unemployment or real GDP. By deciding on an inflation rate and announcing it, the central bank is providing information the public needs to concentrate expectations on a common trend. The central bank gains control indirectly by creating information that makes it more likely that people will price things in a way that is consistent with the central bank's goal. The way to improve inflation targeting is to be more explicit about the average inflation rate expected over all relevant horizons. Building a target path for the price level, growing at the desired inflation rate, is the best way to institutionalize a low-inflation environment. In a wide variety of economic models, a price-path target mitigates the zero lower bound problem, eliminates worries about deflation, and improves the central bank's ability to stabilize the real economy.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2003-027.

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Date of creation: 2003
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Publication status: Published in Business Economics, April 2004, 39(2), pp. 30-37
Handle: RePEc:fip:fedlwp:2003-027

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Keywords: Inflation (Finance) ; Monetary policy;

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Cited by:
  1. William Whitesell, 2005. "An inflation goal with multiple reference measures," Finance and Economics Discussion Series 2005-62, Board of Governors of the Federal Reserve System (U.S.).
  2. William Barnett & Evgeniya Duzhak, 2010. "Empirical assessment of bifurcation regions within New Keynesian models," Economic Theory, Springer, vol. 45(1), pages 99-128, October.
  3. Barnett, William A. & Duzhak, Evgeniya Aleksandrovna, 2008. "Non-robust dynamic inferences from macroeconometric models: Bifurcation stratification of confidence regions," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(15), pages 3817-3825.
  4. Chen, Shu-hua & Shaw, Ming-fu & Lai, Ching-chong & Chang, Juin-jen, 2008. "Interest-rate rules and transitional dynamics in an endogenously growing open economy," Journal of International Money and Finance, Elsevier, vol. 27(1), pages 54-75, February.
  5. William T Gavin, 2007. "Recent Developments in Monetary Macroeconomics and US Dollar Policy," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(3), pages 49-56, August.
  6. Anthony Kyereboah-Coleman, 2012. "Inflation targeting and inflation management in Ghana," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(1), pages 25-40, April.
  7. Sujit Kapadia, 2005. "Inflation-Target Expectations and Optimal Monetary Policy," Economics Series Working Papers 227, University of Oxford, Department of Economics.
  8. Sujit Kapadia, 2005. "Inflation-Target Expectations and Optimal Monetary Policy," Money Macro and Finance (MMF) Research Group Conference 2005 81, Money Macro and Finance Research Group.
  9. Andrés Felipe Giraldo palomino, 2007. "Aversión a la inflación y regla de Taylor en Colombia 1994-2005," DOCUMENTOS DE ECONOMÍA 003947, UNIVERSIDAD JAVERIANA - BOGOTÁ.

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