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Optimal Policy When the Inflation Target is not Optimal

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  • Sergio A. Lago Alves

Abstract

I assess the optimal policy to be followed by a welfare-concerned central bank when assigned an inflation target that is not necessarily welfare-optimal. I treat the inflation target as the trend inflation and I have three main contributions: (i) a welfare-based loss function fully derived under trend inflation, showing how the non-optimal inflation target acts as an extra inefficiency source; (ii) I show that the trend inflation does affect the relative weight of the output gap: they are inversely related; (iii) under trend inflation, I derive time consistent optimal policies with both unconditional and timeless commitment, and I show how to translate the pursuit of the inflation target into an additional constraint in the minimization step.

Suggested Citation

  • Sergio A. Lago Alves, 2012. "Optimal Policy When the Inflation Target is not Optimal," Working Papers Series 271, Central Bank of Brazil, Research Department.
  • Handle: RePEc:bcb:wpaper:271
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    References listed on IDEAS

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    Cited by:

    1. Nakata, Taisuke, 2014. "Welfare costs of shifting trend inflation," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 66-78.
    2. Guido Ascari & Argia M. Sbordone, 2014. "The Macroeconomics of Trend Inflation," Journal of Economic Literature, American Economic Association, vol. 52(3), pages 679-739, September.
    3. Alves, Sergio Afonso Lago, 2014. "Lack of divine coincidence in New Keynesian models," Journal of Monetary Economics, Elsevier, vol. 67(C), pages 33-46.
    4. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
    5. Carl E. Walsh, 2011. "The Future of Inflation Targeting," The Economic Record, The Economic Society of Australia, vol. 87(s1), pages 23-36, September.

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