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Inflation Indicators and Inflation Policy

In: NBER Macroeconomics Annual 1995, Volume 10

  • Stephen G. Cecchetti

In recent years, central bankers throughout the world have advocated that monetary policy shift toward inflation targeting. Recent actions in the U.S. serve to highlight the desire of the Federal Reserve to keep inflation both low and stable, while downplaying the likely output and employment consequences. But control of inflation requires both that one be able to forecast the future path of the price level and that one have estimates of what impact policy changes have on that path. Unfortunately, inflation is very difficult to forecast at even very near horizons. This is true because the relationship of candidate inflation indicators to inflation is neither very strong nor very stable. Beyond this, the relationship between monetary policy instruments, such as the Federal Funds Rate, and inflation also varies substantially over time and cannot be estimated precisely. Construction of policy rules can take these difficulties into account. Several rules are examined, and they have the following interesting properties. First, since prices take time to respond to all types of impulses, the object of price stability implies raising the Federal Funds Rate immediately following a shock, rather than waiting for prices to rise before acting. Finally, comparison of the results of price level targeting with nominal income targeting suggests that the difficulties inherent in forecasting and controlling the former provide an argument for focusing on the latter.

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This chapter was published in:
  • Ben S. Bernanke & Julio J. Rotemberg, 1996. "NBER Macroeconomics Annual 1995, Volume 10," NBER Books, National Bureau of Economic Research, Inc, number bern95-1, October.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11019.
    Handle: RePEc:nbr:nberch:11019
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
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    1. Martin Feldstein & James H. Stock, 1994. "The Use of a Monetary Aggregate to Target Nominal GDP," NBER Chapters, in: Monetary Policy, pages 7-69 National Bureau of Economic Research, Inc.
    2. Robert E. Hall & N. Gregory Mankiw, 1993. "Nominal Income Targeting," NBER Working Papers 4439, National Bureau of Economic Research, Inc.
    3. Steven Strongin, 1992. "The identification of monetary policy disturbances: explaining the liquidity puzzle," Working Paper Series, Macroeconomic Issues 92-27, Federal Reserve Bank of Chicago.
    4. Bruce E. Hansen, 1995. "Approximate Asymptotic P-Values for Structural Change Tests," Boston College Working Papers in Economics 297., Boston College Department of Economics.
    5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    6. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The Effects of Monetary Policy Shocks: Some Evidence from the Flow of Funds," NBER Working Papers 4699, National Bureau of Economic Research, Inc.
    7. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
    8. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-58, September.
    9. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
    10. Sims, Christopher A, 1972. "Money, Income, and Causality," American Economic Review, American Economic Association, vol. 62(4), pages 540-52, September.
    11. Michael Woodford, 1994. "Nonstandard Indicators for Monetary Policy: Can Their Usefulness Be Judged from Forecasting Regressions?," NBER Chapters, in: Monetary Policy, pages 95-115 National Bureau of Economic Research, Inc.
    12. Caskey, John P, 1985. "Modeling the Formation of Price Expectations: A Bayesian Approach," American Economic Review, American Economic Association, vol. 75(4), pages 768-76, September.
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