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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. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2003. "Econometric inflation targeting," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 430-461, December.
  2. 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.).
  3. Akram, Q. Farooq & Eitrheim, Øyvind, 2008. "Flexible inflation targeting and financial stability: Is it enough to stabilize inflation and output?," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1242-1254, July.
  4. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
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  12. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, 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.
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  18. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502, June.
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  22. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
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