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Central Bank Preferences, Distribution Forecasts and Economic Stability in a Small Open-economy

Author

Listed:
  • Alessandro Flamini

    (Department of Economics, The University of Sheffield)

Abstract

This paper relates the central bank's preferences on the inflation index and on the degree of smoothness of the interest rate to the quality of its forecasts and the expected perturbing impact of several shocks. The framework is a Markov jump-linear-quadratic system for optimal policy with model uncertainty in a timeless perspective. Comparing CPI and domestic inflation targeting, the latter implies considerably less variability in the distribution forecast of the economic dynamics. Furthermore, domestic inflation targeting stands out for much less sensitiveness to interest rate smoothing, and for resulting in more expected economic stability. Importantly, domestic inflation targeting allows significantly improving the prediction accuracy of the interest rate behaviour.

Suggested Citation

  • Alessandro Flamini, 2009. "Central Bank Preferences, Distribution Forecasts and Economic Stability in a Small Open-economy," Working Papers 2009005, The University of Sheffield, Department of Economics, revised Mar 2009.
    • Handle: RePEc:shf:wpaper:2009005
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    File URL: http://shef.ac.uk/content/1/c6/09/50/61/SERP2009005.pdf
    File Function: First version, 2009
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    More about this item

    Keywords

    Inflation targeting; additive and multiplicative uncertainty; Markov jump linear quadratic systems; small open-economy; optimal monetary policy; central bank preferences;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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