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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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References

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  1. Teruyoshi Kobayashi & Ichiro Muto, 2011. "A note on expectational stability under non-zero trend inflation," Discussion Papers 1102, Graduate School of Economics, Kobe University.
  2. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  3. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  4. Olivier Coibion & Yuriy Gorodnichenko & Johannes F. Wieland, 2010. "The Optimal Inflation Rate in New Keynesian Models," NBER Working Papers 16093, National Bureau of Economic Research, Inc.
  5. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers, Society for Economic Dynamics 74, Society for Economic Dynamics.
  6. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers, Department of Economics, University of York 00/41, Department of Economics, University of York.
  7. 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.
  8. Bennett T. McCallum, 2006. "E-Stability vis-a-vis Determinacy Results for a Broad Class of Linear Rational Expectations Models," NBER Working Papers 12441, National Bureau of Economic Research, Inc.
  9. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper, Federal Reserve Bank of Cleveland 0107, Federal Reserve Bank of Cleveland.
  10. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(3), pages 507-535, April.
  11. James Bullard & Kaushik Mitra, 2007. "Determinacy, Learnability, and Monetary Policy Inertia," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(5), pages 1177-1212, 08.
  12. Giovanni Dell'Ariccia & Olivier J. Blanchard & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," IMF Staff Position Notes, International Monetary Fund 2010/03, International Monetary Fund.
  13. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research, National Bank of Belgium 35, National Bank of Belgium.
  14. Berardi, Michele & Duffy, John, 2007. "The value of central bank transparency when agents are learning," European Journal of Political Economy, Elsevier, Elsevier, vol. 23(1), pages 9-29, March.
  15. Levin, Andrew & Yun, Tack, 2007. "Reconsidering the natural rate hypothesis in a New Keynesian framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(5), pages 1344-1365, July.
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