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Should the Bank of Israel have a growth target? What are the issues?

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  • Alex Cukierman

    (Tel-Aviv University)

Abstract

The main objective of this paper is to contribute to the public policy discussion regarding whether or not a growth target (or a flexible inflation target) should be assigned to the Bank of Israel by reformulating this question in a way that leads to verifiable and falsifiable propositions. It is shown that the answer to this question depends on the structure of the economy as summarized by the objective tradeoff between stabilization of inflation and stabilization of output. If a change in the interest rate has a strong impact on inflation and little impact on output, strict inflation targeting is indicated. Otherwise, some form of growth (or flexible inflation) targeting is desirable. The paper identifies some of the basic parameters that determine this crucial tradeoff coefficient and utilizes recent estimates to evaluate it. It is also argued that the desirability of growth targeting rises the more inflationary expectations are anchored in the economy. Finally, due to the unobservability of potential output and the output gap, even optimal monetary policy is subject to serially correlated forecast errors. Flexible inflation targeting that assigns a positive weight to stabilization of the output gap leads to larger discrepancies between the actual and the full- information interest rate than strict inflation targeting. The paper also briefly evaluates the case for nominal income targeting

Suggested Citation

  • Alex Cukierman, 2006. "Should the Bank of Israel have a growth target? What are the issues?," Israel Economic Review, Bank of Israel, vol. 4(2), pages 1-18.
  • Handle: RePEc:boi:isrerv:v:4:y:2006:i:2:p:1-18
    as

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    References listed on IDEAS

    as
    1. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    2. 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.
    3. Cukierman, Alex & Lippi, Francesco, 2005. "Endogenous monetary policy with unobserved potential output," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1951-1983, November.
    4. Alex Cukierman, 2002. "Are contemporary central banks transparent about economic models and objectives and what difference does it make?," Review, Federal Reserve Bank of St. Louis, vol. 84(Jul), pages 15-36.
    5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    6. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    7. Leitemo, Kai & Söderström, Ulf, 2008. "Robust monetary policy in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3218-3252, October.
    8. Alex Cukierman, 2005. "Keynesian Economics, Monetary Policy and the Business Cycle – New and Old," CESifo Economic Studies, CESifo, vol. 51(4), pages 697-728.
    9. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
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