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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. Athanasios Orphanides & Simon van Norden, 2001. "The Unreliability of Output Gap Estimates in Real Time," CIRANO Working Papers 2001s-57, CIRANO.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  3. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  4. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  5. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  6. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  7. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
  8. Richard T. Froyen & Alfred V. Guender, 2007. "Optimal Monetary Policy under Uncertainty," Books, Edward Elgar Publishing, number 12510.
  9. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  10. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  11. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
  12. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  13. Nicoletta Batini & Edward Nelson, 2001. "The Lag from Monetary Policy Actions to Inflation: Friedman Revisited," Discussion Papers 06, Monetary Policy Committee Unit, Bank of England.
  14. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  15. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
  16. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
  17. Jordi Galí, 2008. "Introduction to Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework," Introductory Chapters, in: Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework Princeton University Press.
  18. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
  19. 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.
  20. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, December.
  21. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, December.
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