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What horizon for targeting inflation?

  • Q. Farooq Akram.

    (Norges Bank (Central Bank of Norway))

We investigate optimal horizons for targeting inflation in response to different shocks and their properties under alternative preferences of an inflation-targeting central bank. Our analysis is based on a well specified macroeconometric model of Norway, but we examine how alternative specifications of its key equations would affect our results. We find that the optimal horizon is highly shock-specific, precluding general conclusions for demand and supply shocks. An extension of the horizon with concern for output and/or interest rate fluctuations beyond some shock-specific level proves counterproductive. The size of a given shock does not affect the horizon unless the central bank cares about interest rate volatility, while its sign does not matter unless the model is non-linear. The optimal horizon in response to a combination of shocks cannot be derived from those for each of the shocks, as different shocks may amplify or modify the effects of each other. In this case, however, sources of shocks as well as their sizes and signs become relevant, leading to complex dynamics of inflation and output. Successful inflation targeting in such cases may require a complex interest rate response. The optimal horizon generally increases with the degree of persistence in a shock and decreases with the strength of stabilisation mechanisms in the model.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2007/WP-200713/
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Paper provided by Norges Bank in its series Working Paper with number 2007/13.

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Length: 45 pages
Date of creation: 24 Jan 2008
Date of revision:
Handle: RePEc:bno:worpap:2007_13
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  1. Brian P. Sack & Volker W. Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  2. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  3. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  4. Gunnar Bårdsen & Eilev S. Jansen & Ragnar Nymoen, 1999. "Econometric Inflation Targeting," Working Paper Series 0502, Department of Economics, Norwegian University of Science and Technology, revised 30 Oct 2001.
  5. Q. Farooq Akram & Ragnar Nymoen, 2006. "Model selection for monetary policy analysis – Importance of empirical validity," Working Paper 2006/13, Norges Bank.
  6. Eric M. Leeper & Tao Zha, 1999. "Modest policy interventions," FRB Atlanta Working Paper 99-22, Federal Reserve Bank of Atlanta.
  7. 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.
  8. 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.
  9. Scott Roger & Mark R. Stone, 2005. "On Target? the International Experience with Achieving Inflation Targets," IMF Working Papers 05/163, International Monetary Fund.
  10. Nicoletta Batini & Edward Nelson, 1999. "Optimal Horizons for Inflation Targeting," Computing in Economics and Finance 1999 1052, Society for Computational Economics.
  11. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502.
  12. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  13. Laurence H. Meyer, 2004. "Practical problems and obstacles to inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 151-160.
  14. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  15. Q. Farooq Akram & Øyvind Eitrheim, 2006. "Flexible inflation targeting and financial stability: Is it enough to stabilise inflation and output?," Working Paper 2006/07, Norges Bank.
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  17. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  18. repec:pri:cepsud:129blinder is not listed on IDEAS
  19. Laurence Ball, 1999. "Aggregate demand and Long-Run Unemployment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 189-252.
  20. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
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  22. 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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