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Inflation Targeting under Heterogeneous Information and Sticky Prices

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  • Cheick Kader M'Baye

    (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon - Université Jean Monnet - Saint-Etienne - Université Claude Bernard - Lyon I)

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    Abstract

    Under what conditions should a central bank adopt an inflation targeting regime ? This is the main question we address in this paper. A large part of the literature puts forward that these regimes should have to be adopted, as they yield higher macroeconomic performances. We analyze the issue of optimal inflation targeting in a new theoretical framework, which conciliates the interaction between the degree of price stickiness, and the degree of strategic complementarities in fi-rms' price setting. We show that adopting a target for inflation, crucially depends on the sequential but complementary importance of the model's parameters. In particular, we show that strategic complementarities appear to be the fi-rst driving force. When they are low, the central bank must adopt an inflation targeting regime whatever the importance of other parameters in the model. By contrast, when the degree of strategic complementarities is high, adopting a target for in ation depends on both the degree of price stickiness and the precision of central bank's information about the fundamentals of the economy. When prices are exible enough, adopting an inflation target is never optimal. However, when prices are strongly sticky, and the central bank holds precise information about the fundamentals, the central bank should adopt an explicit target for inflation.

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    Bibliographic Info

    Paper provided by HAL in its series Working Papers with number halshs-00677671.

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    Date of creation: 09 Mar 2012
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    Handle: RePEc:hal:wpaper:halshs-00677671

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    Related research

    Keywords: Inflation targeting ; price stickiness ; heterogeneous information ; strategic complementarities;

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    References

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    1. Scott Roger & Mark R. Stone, 2005. "On Target? The International Experience with Achieving Inflation Targets," IMF Working Papers 05/163, International Monetary Fund.
    2. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    3. repec:nbr:nberre:0126 is not listed on IDEAS
    4. Svensson, Lars E O, 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," CEPR Discussion Papers 1249, C.E.P.R. Discussion Papers.
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    13. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    14. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    16. Mauro Roca, 2010. "Transparency and Monetary Policy with Imperfect Common Knowledge," IMF Working Papers 10/91, International Monetary Fund.
    17. Jonathan G. James & Phillip Lawler, 2011. "Optimal Policy Intervention and the Social Value of Public Information," American Economic Review, American Economic Association, vol. 101(4), pages 1561-74, June.
    18. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
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