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The Implications of Transmission and Information Lags for the Stabilization Bias and Optimal Delegation

  • Jean-Paul Lam
  • Florian Pelgrin

In two recent papers, Jensen (2002) and Walsh (2003), using a hybrid New Keynesian model, demonstrate that a regime that targets either nominal income growth or the change in the output gap can effectively replicate the outcome under commitment and hence reduce the size of the stabilization bias. Moreover, these two targeting regimes have been shown to outperform a regime that targets inflation, except when inflation expectations are predominantly backward looking. In this paper, the authors modify an otherwise conventional New Keynesian model to include transmission and information lags, two key problems faced by policy-makers, and they examine whether the results from the baseline model are robust to these two modifications. The authors find that the gains from commitment are considerably reduced when the model includes these two features, which implies that optimal delegation is less important. Furthermore, a regime that targets CPI inflation in a conservative manner is found to perform well and even outperforms the targeting regimes advocated by Jensen and Walsh under certain conditions.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 04-37.

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Length: 32 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bca:bocawp:04-37
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  1. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
  2. Jean-Paul Lam, 2003. "Alternative Targeting Regimes, Transmission lags and the Exchange rate Channel," Macroeconomics 0309005, EconWPA, revised 04 Sep 2003.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  4. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, June.
  5. Dennis, Richard & Soderstrom, Ulf, 2006. "How Important Is Precommitment for Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 847-872, June.
  6. Jensen, Henrik, 1999. "Targeting Nominal Income Growth or Inflation?," CEPR Discussion Papers 2341, C.E.P.R. Discussion Papers.
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  9. Rudebusch, Glenn D., 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 0014, European Central Bank.
  10. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
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  13. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  14. 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.
  15. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  16. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  17. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
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