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Forecast-based monetary policy

  • Thomas Laubach

    (Federal Reserve Board)

  • Jeffery D. Amato

    (Goldman Sachs International)

This article analyses the welfare consequences of delegating to the central bank the task of minimising deviations of forecasts of goal variables from their target values. The delegated objectives considered in this article are motivated by the observation that central banks oftentimes operate under objectives which do not necessarily represent society's preferences. The analysis is performed using an estimated model of optimising households and firms that generates tradeoffs between stabilising wage and price inflation and the output gap. We find that when the central bank's objective is defined solely in terms of price inflation, it is welfare optimal to stabilise only those fluctuations in price inflation that are forecastable at least five quarters ahead. On the other hand, when the central bank's objective involves both wage and price inflation stabilisation, the central bank should stabilise all fluctuations in these variables, not just those forecastable at some horizon.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 89.

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Length: 40 pages
Date of creation: Aug 2000
Date of revision:
Handle: RePEc:bis:biswps:89
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  1. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  2. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  3. Nicoletta Batini & Edward Nelson, 2000. "Optimal horizons for inflation targeting," Bank of England working papers 119, Bank of England.
  4. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
  5. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  6. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  7. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  8. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  9. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  10. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  11. Thomas Laubach & Jeffery D. Amato, 2000. "Monetary policy in an estimated optimisation-based model with sticky prices and wages," BIS Working Papers 87, Bank for International Settlements.
  12. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  14. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  15. 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.
  16. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  17. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  18. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  19. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers 590, Board of Governors of the Federal Reserve System (U.S.).
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