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Inflation Targeting: a Framework for Communication

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  • Maria Demertzis
  • Nicola Viegi

Abstract

More than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being ‘successful’. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.

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Bibliographic Info

Paper provided by Economic Research Southern Africa in its series Working Papers with number 71.

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Date of creation: 2008
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Handle: RePEc:rza:wpaper:71

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Cited by:
  1. Gabriele Galati & John Lewis & Steven Poelhekke & Chen Zhou, 2011. "Have market views on the sustainability of fiscal burdens influenced monetary authorities' credibility?," DNB Working Papers, Netherlands Central Bank, Research Department 304, Netherlands Central Bank, Research Department.
  2. Naraidoo, Ruthira & Paya, Ivan, 2012. "Forecasting monetary policy rules in South Africa," International Journal of Forecasting, Elsevier, Elsevier, vol. 28(2), pages 446-455.
  3. Maria Demertzis & Massimiliano Marcellino & Nicola Viegi, 2009. "Anchors for Inflation Expectations," DNB Working Papers, Netherlands Central Bank, Research Department 229, Netherlands Central Bank, Research Department.
  4. Demertzis, Maria & Marcellino, Massimiliano & Viegi, Nicola, 2008. "A Measure for Credibility: Tracking US Monetary Developments," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7036, C.E.P.R. Discussion Papers.
  5. Yakov Ben-Haim & Maria Demertzis, 2008. "Confidence in Monetary Policy," DNB Working Papers, Netherlands Central Bank, Research Department 192, Netherlands Central Bank, Research Department.
  6. Luba Petersen, 2014. "Forecast Error Information and Heterogeneous Expectations in Learning-to-Forecast Experiments," Discussion Papers dp14-05, Department of Economics, Simon Fraser University.
  7. Cheick Kader M'baye, 2012. "Inflation Targeting under Heterogeneous Information and Sticky Prices," Working Papers, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure 1202, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
  8. Salle, Isabelle & Yıldızoğlu, Murat & Sénégas, Marc-Alexandre, 2013. "Inflation targeting in a learning economy: An ABM perspective," Economic Modelling, Elsevier, Elsevier, vol. 34(C), pages 114-128.
  9. Isabelle SALLE & Marc-Alexandre SENEGAS & Murat YILDIZOGLU, 2013. "How Transparent About Its Inflation Target Should a Central Bank be? An Agent-Based Model Assessment," Cahiers du GREThA, Groupe de Recherche en Economie Théorique et Appliquée 2013-24, Groupe de Recherche en Economie Théorique et Appliquée.

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