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Practical Monetary Policies

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This paper investigates the theoretical implications of targeting average inflation or following a speed limit policy in a dynamic backward-looking model where monetary policy works with lags. Our findings reveal that the target horizon for expected inflation in the target rule must be correctly specified for the monetary policy strategies to achieve best results. Average inflation targeting dominates a speed limit policy for plausible values of society s relative aversion to inflation variability. The efficiency loss associated with average inflation targeting relative to optimal policy is very small if society values output stability. A speed limit policy becomes attractive only if society places great emphasis on inflation stability. Classification-E5

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2008/15.

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Length: 29 p.
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:nzb:nzbdps:2008/15

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  1. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  2. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, Wiley Blackwell, vol. 2(1), pages 63-83, April.
  3. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(3), pages 605-631, April.
  4. Athanasios Orphanides & Simon van Norden, 2001. "The Unreliability of Output Gap Estimates in Real Time," CIRANO Working Papers, CIRANO 2001s-57, CIRANO.
  5. J. M. Culbertson, 1960. "Friedman on the Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 68, pages 617.
  6. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  7. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 69, pages 447.
  8. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  9. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
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