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Transparency, Expectations Anchoring and the Inflation Target

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  • Guido Ascari

    ()
    (Department of Economics and Management, University of Pavia)

  • Anna Florio

    ()
    (Polytechnic of Milan)

Abstract

This paper proves that a higher inflation target unanchors expectations, as feared by Fed Chairman Bernanke. It does so both asymptotically, because it shrinks the E-stability region when a central bank follows a Taylor rule, and in the transition phase, because it slows down the speed of convergence of expectations. Moreover, the higher the inflation target, the more the policy should respond to inflation and the less to output to guarantee E-stability. Hence, a policy that increases the inflation target and increase the monetary policy response to output would be "reckless". Moreover, we show that transparency is an essential component of the inflation targeting framework and it helps anchoring expectations. However, the importance of being transparent diminishes with the level of the inflation target.

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File URL: http://economia.unipv.it/docs/dipeco/quad/ps/RePEc/pav/demwpp/DEMWP0022.pdf
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Bibliographic Info

Paper provided by University of Pavia, Department of Economics and Management in its series DEM Working Papers Series with number 022.

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Length: 48 pages
Date of creation: Nov 2012
Date of revision:
Handle: RePEc:pav:demwpp:022

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Keywords: Trend Inflation; Learning; Monetary Policy; Trasparency;

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  1. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  2. Kobayashi, Teruyoshi & Muto, Ichiro, 2010. "A note on expectational stability under non-zero trend inflation," MPRA Paper 22952, University Library of Munich, Germany.
  3. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  4. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," Discussion Papers 0708-10, Columbia University, Department of Economics.
  5. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  7. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  8. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2010. "The Optimal Inflation Rate in New Keynesian Models," Working Papers 91, Department of Economics, College of William and Mary.
  9. Giovanni Dell'Ariccia & Olivier J. Blanchard & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," IMF Staff Position Notes 2010/03, International Monetary Fund.
  10. McCallum, Bennett T., 2007. "E-stability vis-a-vis determinacy results for a broad class of linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1376-1391, April.
  11. Guido Ascari, 2004. "Staggered Prices and Trend Inflation: Some Nuisances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 642-667, July.
  12. Berardi, Michele & Duffy, John, 2007. "The value of central bank transparency when agents are learning," European Journal of Political Economy, Elsevier, vol. 23(1), pages 9-29, March.
  13. James Bullard & Kaushik Mitra, 2007. "Determinacy, Learnability, and Monetary Policy Inertia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1177-1212, 08.
  14. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  15. Levin, Andrew & Yun, Tack, 2007. "Reconsidering the natural rate hypothesis in a New Keynesian framework," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1344-1365, July.
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