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Nonlinearity in monetary policy: A reconsideration of the opportunistic approach to disinflation

  • Marzo, Massimiliano
  • Strid, Ingvar
  • Zagaglia, Paolo

The proponents of the 'opportunistic' approach to disinflation suggest that, when inflation is close to the target, the central bank should not counteract inflationary pressures. Orphanides and Wilcox (2002) formalize this idea through a simple policy rule that prescribes a nonlinear adjustment to a history-dependent target for inflation. This embodies a regime change in monetary policy, which reacts to inflation only when this is far from the inflation target. Here we study the opportunistic approach in a New-Keynesian model with sizeable nominal and real rigidites in the form of a positive money demand and adjustment costs for investment. We find that the welfare gains delivered by the opportunistic rule arise from the time-varying inflation target, when welfare is measured by a quadratic approximation of household utility. The nonlinear zone of inaction on inflation improves welfare outcomes only when a central bank loss function with the absolute value of the output gap is used, as proposed by Orphanides and Wilcox (2002).

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Article provided by Elsevier in its journal Structural Change and Economic Dynamics.

Volume (Year): 20 (2009)
Issue (Month): 4 (December)
Pages: 288-300

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Handle: RePEc:eee:streco:v:20:y:2009:i:4:p:288-300
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/525148

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  1. Matthias Paustian, 2003. "Gains from second-order approximations," Bonn Econ Discussion Papers bgse25_2003, University of Bonn, Germany.
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  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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  12. Orphanides, Athanasios & Wilcox, David W, 2002. "The Opportunistic Approach to Disinflation," International Finance, Wiley Blackwell, vol. 5(1), pages 47-71, Spring.
  13. David Laidler, 2002. "Inflation Targets Versus International Monetary Integration: A Canadian Perspective," University of Western Ontario, Economic Policy Research Institute Working Papers 20023, University of Western Ontario, Economic Policy Research Institute.
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