Inflation Rules with Consistent Escape Clauses
AbstractSimple inflation targets may be supplemented with an escape clause to be evoked in case the economy is hit by a major supply shock. In this paper, consistent solutions to the Flood and Isard (1990) escape clause model are derived in the spirit of Lohmann (1990), She showed that Flood and Isard's assumption of symmetric boundary values of shocks, outside of which the zero inflation rule should be broken, is inconsistent if the output or employment target differs from the natural rate. This is quantitatively important since the optimal boundary values in the consistent model are highly asymmetric. The effects of unemployment persistence on the optimal escape clause are also investigated in a two period version of the model. In the second period, monetary policy should respond more often to supply shocks if unemployment is persistent. The first period effect may be of either sign.
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Bibliographic InfoPaper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 92.
Length: 35 pages
Date of creation: Jan 1996
Date of revision:
Publication status: Forthcoming in European Economic Review.
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Escape clauses; monetary policy;
Other versions of this item:
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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