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Defining Inflation Targets, the Policy Horizon and the Output-Inflation Tradeoff

  • Jose De Gregorio

This paper shows the equivalence between different approaches to defining a central bank’s inflation objective. Defining a range and the percentage of time that inflation is expected to lie within that range is the same as defining a target for projected inflation within a given horizon. Both these definitions are in turn similar to defining the target in terms of the expected value and desired variance of inflation. All these definitions are connected by the actual process of inflation. A more volatile or persistent inflation increases the policy horizon. The paper also presents evidence on how inflation targets are actually defined in many countries and compares these stated targets with that implied by the actual process of inflation. To interpret these results, the paper presents a simple model, generalized in the appendices, to show how the central bank’s tolerance of deviations from the target, as well as the policy horizon, depend on the cost of output deviations from full employment, and on the slope and degree of backward-lookingness of the Phillips curve.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 415.

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Date of creation: Mar 2007
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Handle: RePEc:chb:bcchwp:415
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  1. Luca Gambetti & Jordi Gal�, 2009. "On the Sources of the Great Moderation," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 26-57, January.
  2. Perron, P., 1989. "Testing For A Unit Root In A Time Series With A Changing Mean," Papers 347, Princeton, Department of Economics - Econometric Research Program.
  3. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  4. Gerard O'Reilly & Karl Whelan, 2005. "Has Euro-Area Inflation Persistence Changed Over Time?," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 709-720, November.
  5. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  6. de Gregorio, Jose, 1995. "Policy Accommodation and Gradual Stabilizations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 727-41, August.
  7. Filippo Altissimo & Michael Ehrmann & Frank Smets, 2006. "Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence," Occasional Paper Series 46, European Central Bank.
  8. repec:nbr:nberre:0126 is not listed on IDEAS
  9. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  10. Christopher Bowdler, 2005. "Openness, exchange rate regimes and the Phillips curve," Economics Papers 2005-W25, Economics Group, Nuffield College, University of Oxford.
  11. David Romer, 1991. "Openness and inflation: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  12. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  13. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  14. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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