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Inflation targeting under potential output uncertainty

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    Abstract

    In this paper, measures of the uncertainty surrounding estimates of New Zealand's potential output are used to consider whether the output gap is a useful concept for the monetary authority to base policy actions on. The analysis relies on stochastic simulations of the Reserve Bank of New Zealand's Forecasting and Policy System macroeconomic model (FPS). The analysis shows that when the policymakers' estimates of the output gap have large serially correlated errors that are positively correlated with the business cycle, both output and inflation become more variable. However, the output gap is still useful for stabilising output and inflation. Basing policy actions on the output gap directly and/or indirectly through forecasts of inflation leads to better macroeconomic stability than basing policy actions solely on currently available observable data such as inflation and output growth.

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    File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2000/dp00_8.pdf
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    Bibliographic Info

    Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2000/08.

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    Length: 28p
    Date of creation: Apr 2000
    Date of revision:
    Handle: RePEc:nzb:nzbdps:2000/08

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    1. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-50, Board of Governors of the Federal Reserve System (U.S.).
    2. Aaron Drew & Ben Hunt, 1998. "The Forecasting and Policy System: stochastic simulations of the core model," Reserve Bank of New Zealand Discussion Paper Series G98/6, Reserve Bank of New Zealand.
    3. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, Elsevier, vol. 52(1-2), pages 143-160.
    4. Ann-Charlotte Eliasson & Peter Isard & Douglas Laxton, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," IMF Working Papers 99/75, International Monetary Fund.
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    7. Arturo Estrella & Frederic S. Mishkin, 1999. "Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 405-436 National Bureau of Economic Research, Inc.
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    19. David Hargreaves, 1999. "SDS-FPS: a small demand-side version of the Forecasting and Policy System core model," Reserve Bank of New Zealand Discussion Paper Series G99/10, Reserve Bank of New Zealand.
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    Cited by:
    1. Gonzalo Llosa/Shirley Miller, 2004. "Using additional information in estimating output gap in Peru: a multivariate unobserved component approach," Econometric Society 2004 Latin American Meetings, Econometric Society 243, Econometric Society.
    2. Ehrmann, Michael & Smets, Frank, 2001. "Uncertain potential output: implications for monetary policy," Working Paper Series, European Central Bank 0059, European Central Bank.
    3. Jean-Philippe Cayen & Simon van Norden, 2002. "La fiabilité des estimations de l'écart de production au Canada," Working Papers, Bank of Canada 02-10, Bank of Canada.
    4. Douglas Laxton & Ben Hunt, 2001. "The Zero Interest Rate Floor (ZIF) and its Implications for Monetary Policy in Japan," IMF Working Papers 01/186, International Monetary Fund.
    5. Nadia Saleem, 2010. "Adopting Inflation Targeting in Pakistan: An Empirical Analysis," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, Department of Economics, The Lahore School of Economics, vol. 15(2), pages 51-76, Jul-Dec.
    6. L Christopher Plantier & Dean Scrimgeour, 2002. "Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate," Reserve Bank of New Zealand Discussion Paper Series DP2002/06, Reserve Bank of New Zealand.
    7. Gonzalo Llosa & Shirley Miller, 2005. "Using additional information in estimating the output gap in Peru: a multivariate unobserved component approach," Working Papers, Banco Central de Reserva del Perú 2005-004, Banco Central de Reserva del Perú.

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