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Flexibility in inflation targeting, financial markets and macroeconomic stability

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  • Dai, Meixing
  • Sidiropoulos, Moïse

Abstract

Using an aggregate dynamic macroeconomic model, we study the macroeconomic and financial stability under flexible inflation-targeting regime associated with intermediate monetary growth target. Central banks, using the inflation target as a communication and strong nominal anchoring device, should also take into account the movements of asset prices in their optimal interest rate rule. They might react to changes in asset prices without introducing asset prices into the description of their policy objectives. We show that, the more flexible the inflation-targeting framework of monetary policy is, the more likely the monetary authorities are able to stabilise the economy around the long-term equilibrium. Therefore, achieving price stability under inflation-targeting regime with low flexibility can generate dynamic instability and will not be able to stabilise effectively the fluctuations of output and inflation. A commitment to a long run growth rate of money supply corresponding to the inflation target can reinforce the credibility of the central bank and the role of inflation target as strong and credible nominal anchor for private inflation expectations and allows the system to be more stability prone.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13864.

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Date of creation: May 2005
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Handle: RePEc:pra:mprapa:13864

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Keywords: Flexible inflation targeting; monetary targeting; optimal interest rate rule; stock price; financial development; financial markets; financial and macroeconomic instability;

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  1. Takatoshi Ito, 2004. "Inflation Targeting and Japan: Why has the Bank of Japan not Adopted Inflation Targeting?," NBER Working Papers 10818, National Bureau of Economic Research, Inc.
  2. Stephen P Millard & Simon J Wells, 2003. "The role of asset prices in transmitting monetary and other shocks," Bank of England working papers 188, Bank of England.
  3. Frederic S. Mishkin, 2000. "Inflation Targeting in Emerging Market Countries," NBER Working Papers 7618, National Bureau of Economic Research, Inc.
  4. Frederic S. Mishkin & Adam S. Posen, 1998. "Inflation Targeting: Lessons from Four Countries," NBER Working Papers 6126, National Bureau of Economic Research, Inc.
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  6. Takatoshi Ito & Frederic S. Mishkin, 2004. "Two Decades of Japanese Monetary Policy and the Deflation Problem," NBER Working Papers 10878, National Bureau of Economic Research, Inc.
  7. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
  8. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
  9. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  10. William Poole, 2001. "What role for asset prices in U.S. monetary policy?," Speech 57, Federal Reserve Bank of St. Louis.
  11. Frederic S. Mishkin, 1999. "International Experiences with Different Monetary Policy Regimes," NBER Working Papers 6965, National Bureau of Economic Research, Inc.
  12. Svensson, Lars, 2000. "The first Year of the Eurosystem: Inflation Targeting or Not?," Seminar Papers 681, Stockholm University, Institute for International Economic Studies.
  13. Michael D. Bordo & David C. Wheelock, 2004. "Monetary Policy and Asset Prices: A Look Back at Past U.S. Stock Market Booms," NBER Working Papers 10704, National Bureau of Economic Research, Inc.
  14. Rudebusch, Glenn & Svensson, Lars, 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," Seminar Papers 672, Stockholm University, Institute for International Economic Studies.
  15. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
  16. Lars E O Svensson, 1997. "Inflation targeting in an open economy: strict or flexible inflation targeting?," Reserve Bank of New Zealand Discussion Paper Series G97/8, Reserve Bank of New Zealand.
  17. Sean Collins & Pierre L. Siklos, 2004. "Optimal Monetary Policy Rules and Inflation Targets: Are Australia, Canada, and New Zealand Different from the U.S.?," Open Economies Review, Springer, vol. 15(4), pages 347-362, October.
  18. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  19. Marvin Goodfriend, 2003. "Inflation Targeting in the United States?," NBER Working Papers 9981, National Bureau of Economic Research, Inc.
  20. 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.
  21. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  22. Dai, Meixing & Sidiropoulos, Moïse, 2002. "Règle du taux d'intérêt optimale, prix des actions et taux d'inflation anticipé : une étude de la stabilité macroéconomique
    [Optimal interest rate rule, asset prices and expected inflation r
    ," MPRA Paper 14401, University Library of Munich, Germany, revised Jun 2003.
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