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Practical Monetary Policies

  • Alfred V. Guender
  • David R. Gillmore

This paper compares a monetary policy that targets average inflation with one that targets the change in the output gap. It shows that the stabilizing properties of monetary policy strategies are sensitive to both the existence of lags in the transmission mechanism and the design of target rules. A strategy focusing on the change in the output gap is likely to prove inferior to targeting the average rate of inflation in a model where monetary policy affects the real economy sooner than inflation. Even more favourable results for average inflation targeting emerge in a framework that also includes forward-looking expectations. These results stand in marked contrast to those in standard models where policy lags are absent. To ensure sound choice of policy, central banks are advised to examine the stabilizing properties of monetary policies in a variety of models. Copyright 2010 Blackwell Publishing Ltd

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Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 13 (2010)
Issue (Month): 1 (03)
Pages: 25-53

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Handle: RePEc:bla:intfin:v:13:y:2010:i:1:p:25-53
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  1. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  2. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  3. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  4. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  5. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  6. Athanasios Orphanides & Simon van Norden, 1999. "The reliability of output gap estimates in real time," Finance and Economics Discussion Series 1999-38, Board of Governors of the Federal Reserve System (U.S.).
  7. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  8. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
  9. J. M. Culbertson, 1960. "Friedman on the Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 68, pages 617.
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