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Inflation rules with consistent escape clauses

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  • Alexius, Annika

Abstract

Simple inflation targets may be supplemented with an escape clause to be evoked in case the economy is hit by a major supply shock. In this paper, consistent solutions to the Flood and Isard (1990) escape clause model are derived in the spirit of Lohmann (1990), She showed that Flood and Isard's assumption of symmetric boundary values of shocks, outside of which the zero inflation rule should be broken, is inconsistent if the output or employment target differs from the natural rate. This is quantitatively important since the optimal boundary values in the consistent model are highly asymmetric. The effects of unemployment persistence on the optimal escape clause are also investigated in a two period version of the model. In the second period, monetary policy should respond more often to supply shocks if unemployment is persistent. The first period effect may be of either sign.
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  • Alexius, Annika, 1999. "Inflation rules with consistent escape clauses," European Economic Review, Elsevier, vol. 43(3), pages 509-523, March.
    • Handle: RePEc:eee:eecrev:v:43:y:1999:i:3:p:509-523
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    References listed on IDEAS

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    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 100(4), pages 1169-1189.
    2. Obstfeld, Maurice, 1997. "Destabilizing effects of exchange-rate escape clauses," Journal of International Economics, Elsevier, vol. 43(1-2), pages 61-77, August.
    3. Susanne Lohmann, 1990. "Monetary Policy Strategies: A Correction: Comment on Flood and Isard," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 440-445, June.
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    7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
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    Cited by:

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    2. Meon, Pierre-Guillaume, 2001. "A Model of Exchange Rate Crises with Partisan Governments," Journal of Macroeconomics, Elsevier, vol. 23(4), pages 517-535, October.
    3. Roszbach, Kasper, 1997. "Reaction Function Estimation when Central Banks Face Adjustment Costs," SSE/EFI Working Paper Series in Economics and Finance 155, Stockholm School of Economics.
    4. Driffill, John & Rotondi, Zeno, 2004. "Monetary Policy and Lexicographic Preference Ordering," CEPR Discussion Papers 4247, C.E.P.R. Discussion Papers.

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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