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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. Nessén, Marianne & Vestin, David, 2000. "Average Inflation Targeting," Working Paper Series 119, Sveriges Riksbank (Central Bank of Sweden).
  2. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  3. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  4. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  6. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
  7. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  8. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, March.
  9. Athanasios Orphanides & John C. Williams, 2003. "Robust monetary policy rules with unknown natural rates," Finance and Economics Discussion Series 2003-11, Board of Governors of the Federal Reserve System (U.S.).
  10. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  11. Athanasios Orphanides & Simon van Norden, 2002. "The Unreliability of Output-Gap Estimates in Real Time," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 569-583, November.
  12. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  13. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  14. 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.
  15. 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.
  16. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, December.
  17. Richard T. Froyen & Alfred V. Guender, 2007. "Optimal Monetary Policy under Uncertainty," Books, Edward Elgar Publishing, number 12510.
  18. 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.
  19. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
  20. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
  21. 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.
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