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Inflation Targeting Under Imperfect Policy Credibility

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  • International Monetary Fund

Abstract

This paper presents a model for Inflation Targeting under imperfect policy credibility. It modifies the conventional model in three ways: an endogenous policy credibility process, by which monetary policy can gain or lose credibility over time; non-linearities in the inflation equation and in the credibility generating process; and an explicit loss function. The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets. Also, unfavorable supply shocks pose a difficult problem: an appropriate response involves an interest rate increase, some loss of output, and a period of increased inflation. A delayed response can result in a prolonged period of stagflation.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/94.

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Length: 30
Date of creation: 01 Apr 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/94

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Keywords: Disinflation; Inflation targeting; Emerging markets; Price increases; Economic models; inflation; monetary policy; central bank; inflation rate; rate of inflation; real interest rate; inflation target; monetary fund; low inflation; real interest rates; inflation objective; nominal interest rates; national bank; monetary economics; aggregate demand; monetary instrument; high inflation; price level; inflation equation; nominal interest rate; inflation-targeting; inflation rates; expectations of inflation; actual inflation; increase in inflation; inflation process; optimal monetary policy; real rate of interest; monetary conditions; high ? inflation; lower inflation; monetary policy rules; effects of inflation; inflationary consequences; monetary policy objectives; price stability; reduction in inflation; low ? inflation; acceleration in inflation; low rate of inflation; inflationary spiral; rise in inflation; inflation dynamics;

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References

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  1. Douglas Laxton & Guy Debelle, 1996. "Is the Phillips Curve Really a Curve? Some Evidence for Canada, the United Kingdom, and the United States," IMF Working Papers 96/111, International Monetary Fund.
  2. Charles Freedman & Douglas Laxton, 2009. "Why Inflation Targeting?," IMF Working Papers 09/86, International Monetary Fund.
  3. Blanchard, Olivier J & Galí, Jordi, 2005. "Real Wage Rigidities and the New Keynesian Model," CEPR Discussion Papers 5375, C.E.P.R. Discussion Papers.
  4. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  5. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.).
  6. Eyal Argov & David Rose & Philippe D Karam & Natan P. Epstein & Douglas Laxton, 2007. "Endogenous Monetary Policy Credibility in a Small Macro Model of Israel," IMF Working Papers 07/207, International Monetary Fund.
  7. Nicoletta Batini & Douglas Laxton, 2007. "Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets," Central Banking, Analysis, and Economic Policies Book Series, in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 12, pages 467-506 Central Bank of Chile.
  8. Scott Roger & Mark R. Stone, 2005. "On Target? the International Experience with Achieving Inflation Targets," IMF Working Papers 05/163, International Monetary Fund.
  9. Miguel A. Savastano & Paul R. Masson & Sunil Sharma, 1997. "The Scope for Inflation Targeting in Developing Countries," IMF Working Papers 97/130, International Monetary Fund.
  10. Eichengreen, B. & Masson, P. & Savastano, M. & Sharma, S., 1999. "Transition Strategies and Nominal Anchors on the Road to Greater Exchange-Rate Flexibility," Princeton Essays in International Economics 213, International Economics Section, Departement of Economics Princeton University,.
  11. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 2001. "Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibility," IMF Working Papers 01/7, International Monetary Fund.
  12. Andrew T. Levin & Fabio M. Natalucci & Jeremy M. Piger, 2004. "The macroeconomic effects of inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 51-80.
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Citations

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Cited by:
  1. Sznajderska, Anna, 2014. "Asymmetric effects in the Polish monetary policy rule," Economic Modelling, Elsevier, vol. 36(C), pages 547-556.
  2. Douglas Laxton & Alasdair Scott & David Rose, 2009. "Developing a Structured Forecasting and Policy Analysis System to Support Inflation-Forecast Targeting (IFT)," IMF Working Papers 09/65, International Monetary Fund.
  3. Charles Freedman & Douglas Laxton, 2009. "Why Inflation Targeting?," IMF Working Papers 09/86, International Monetary Fund.
  4. Matthias Neuenkirch & Peter Tillmann, 2012. "Inflation Targeting, Credibility, and Non-Linear Taylor Rules," MAGKS Papers on Economics 201235, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  5. Man-Keung Tang & Xiangrong Yu, 2011. "Communication of Central Bank Thinking and Inflation Dynamics," IMF Working Papers 11/209, International Monetary Fund.
  6. Pablo Mendieta Ossio, 2010. "The renaissance of Friedman hypothesis: nature of global financial crisis and consequences in a small open and highly dollarized economy," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 13(1), pages 119-151, December.
  7. Inci Ötker & Charles Freedman, 2009. "Country Experiences with the Introduction and Implementation of Inflation Targeting," IMF Working Papers 09/161, International Monetary Fund.
  8. Douglas Laxton & Charles Freedman, 2009. "It Framework Design Parameters," IMF Working Papers 09/87, International Monetary Fund.

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