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The Implications of Information Lags for the Stabilization Bias and Optimal Delegation

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  • Jean-Paul Lam

    ()
    (University of Waterloo, Canada and The Rimini Centre for Economics Analysis, Italy.)

  • Florian Pelgrin

    ()
    (University of Lausanne, Switzerland)

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    Abstract

    Many papers for example Jensen (2002) and Walsh (2003) have shown that in a New Keynesian model with a significant degree of forward-looking behaviour, policy regimes that target either the change in the output-gap (speed limit targeting) or nominal income growth can considerably reduce the size of the stabilization biasÐthe inefficiency that arises when a central bank conducts policy under discretion as opposed to commitment. Inflation targeting can also reduce the size of the stabilization bias but unless inflation expectations in the model are predominantly backward-looking, this targeting regime does not perform as well as speed limit or nominal income growth targeting. Jensen (2002) and Walsh (2003) obtain their results using a New Keynesian model where changes in the policy rate affect macroeconomic variables immediately. In this paper, we compare the performance of several targeting regimes by using a New Keynesian model that includes a delayed response of monetary policy as a result of information lags. We find two results that are substantially different from Jensen (2002) and Walsh (2003). First the size of the stabilization bias is considerably reduced. Second, a regime that targets inflation outperforms a regime that targets either the change in the output-gap or the growth in nominal income even when inflation expectations are very forward-looking.

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    Bibliographic Info

    Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 39-07.

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    Date of creation: Jul 2007
    Date of revision: Jul 2007
    Handle: RePEc:rim:rimwps:39-07

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    Keywords: Stabilization bias; Inflation Targeting; Discretion; Commitment; Information Lag;

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    1. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    2. Glenn D. Rudebusch, 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 2000-03, Federal Reserve Bank of San Francisco.
    3. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    4. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    5. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
    6. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
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