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Alternative Targeting Regimes, Transmission Lags, and the Exchange Rate Channel

  • Jean-Paul Lam

Using a closed-economy model, Jensen (2002) and Walsh (2003) have, respectively, shown that a policy regime that optimally targets nominal income growth (NIT) or the change in the output gap (SLT) outperforms a regime that targets inflation, because NIT and SLT induce more inertia in the actions of the central bank, effectively replicating the outcome obtained under precommitment. The author obtains a very different result when the analysis is extended to open-economy models. Flexible CPI-inflation targeting outperforms both SLT and NIT and is the most robust targeting regime. The gains from targeting CPI inflation are particularly large when the model features transmission lags and/or departures from the uncovered interest parity condition. The author also finds that the stabilization bias inherent in discretionary policy is smaller in an open-economy setting.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 03-39.

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Length: 38 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:bca:bocawp:03-39
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  2. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
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  8. 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.
  9. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  10. Bennett T. McCallum, 1997. "The alleged instability of nominal income targeting," Reserve Bank of New Zealand Discussion Paper Series G97/6, Reserve Bank of New Zealand.
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  18. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  19. Söderström, Ulf, 2001. "Targeting Inflation with a Prominent Role for Money," Working Paper Series 123, Sveriges Riksbank (Central Bank of Sweden).
  20. Vestin, David, 2000. "Price-level Targeting versus Inflation Targeting in a Forward-looking Model," Working Paper Series 106, Sveriges Riksbank (Central Bank of Sweden).
  21. Leitemo, Kai & Roisland, Oistein & Torvik, Ragnar, 2002. " Time Inconsistency and the Exchange Rate Channel of Monetary Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(3), pages 391-97, September.
  22. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
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  24. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
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