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Forecast-based monetary policy

Author

Listed:
  • Thomas Laubach

    (Federal Reserve Board)

  • Jeffery D. Amato

    (Goldman Sachs International)

Abstract

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.

Suggested Citation

  • Thomas Laubach & Jeffery D. Amato, 2000. "Forecast-based monetary policy," BIS Working Papers 89, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:89
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    References listed on IDEAS

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    1. 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.
    2. Jeffery D. Amato & Thomas Laubach, 1999. "Monetary policy in an estimated optimization-based model with sticky prices and wages," Research Working Paper 99-09, Federal Reserve Bank of Kansas City.
    3. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, pages 1111-1146.
    4. 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.
    5. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
    6. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    7. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
    8. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-1286, September.
    9. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    10. Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, pages 337-361.
    11. Batini, Nicoletta & Nelson, Edward, 2001. "Optimal horizons for inflation targeting," Journal of Economic Dynamics and Control, Elsevier, pages 891-910.
    12. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters,in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
    13. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-684, November.
    14. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, pages 281-313.
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    Cited by:

    1. Lance J. Bachmeier & Norman R. Swanson, 2005. "Predicting Inflation: Does The Quantity Theory Help?," Economic Inquiry, Western Economic Association International, vol. 43(3), pages 570-585, July.
    2. Smets, Frank, 2000. "What horizon for price stability," Working Paper Series 0024, European Central Bank.
    3. Orphanides, Athanasios, 2004. "Monetary Policy Rules, Macroeconomic Stability, and Inflation: A View from the Trenches," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(2), pages 151-175, April.
    4. Ahmad, Saad, 2016. "A multiple threshold analysis of the Fed's balancing act during the Great Moderation," Economic Modelling, Elsevier, vol. 55(C), pages 343-358.
    5. Jansson, Per & Vredin, Anders, 2001. "Forecast-based Monetary Policy in Sweden 1992-1998: A View from Within," Working Paper Series 120, Sveriges Riksbank (Central Bank of Sweden).
    6. Per Jansson & Anders Vredin, 2001. "Forecast-based monetary policy in Sweden 1992-98: a view from within," BIS Papers chapters,in: Bank for International Settlements (ed.), Empirical studies of structural changes and inflation, volume 3, pages 204-226 Bank for International Settlements.
    7. Muscatelli, Anton & Trecroci, Carmine, 2000. " Monetary Policy Rules, Policy Preferences, and Uncertainty: Recent Empirical Evidence," Journal of Economic Surveys, Wiley Blackwell, vol. 14(5), pages 597-627, December.

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