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Optimal Monetary Policy Rules under Inflation Range Targeting

In: Monetary Policy: Rules and Transmission Mechanisms

  • Juan Pablo Medina

    (Banco Central de Chile)

  • Rodrigo O. Valdés

    (International Monetary Fund)

We calculate and compare optimal monetary policy (MP) rules for a simple economy under alternative central bank objective (loss) functions. We compare both soft- and hard-edges range (zone) targeting as well as asymmetric loss-functions to a quadratic loss case. The latter represents the standard loss-function for point inflation targeting. The results show that MP aggressiveness under range targeting critically depends on how hard are the edges of this range. If a range is thought of as a thick point objective, MP is always active (there are no inaction zones), although it is less aggressive against inflation and output shocks if range edges are sufficiently soft (vis-à-vis a point target). Harder edges makes MP more aggressive even when the economy is close to the central part of the range. Finally, an asymmetric loss-function for inflation that penalizes positive deviations relatively more generates a bias against output.

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This chapter was published in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Monetary Policy: Rules and Transmission Mechanisms, , chapter 5, pages 095-116, 2002.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v04c05pp095-116.
Handle: RePEc:chb:bcchsb:v04c05pp095-116
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  1. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  2. Svensson, Lars E O, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," CEPR Discussion Papers 1511, C.E.P.R. Discussion Papers.
  3. Frederic S. Mishkin & Adam S. Posen, 1997. "Inflation targeting: lessons from four countries," Economic Policy Review, Federal Reserve Bank of New York, issue Aug, pages 9-110.
  4. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  5. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, June.
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