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The Inflation Forecast and the Loss Function

  • Svensson, Lars E O

This Paper argues that inflation-targeting central banks should announce explicit loss function with numerical relative weights on output-gap stabilization and use and announce optimal time-varying instrument-rate paths and corresponding inflation and output-gap forecasts. Simple voting procedures for forming the Monetary Policy Committee’s aggregate loss function and time-varying instrument-rate paths are suggested. Announcing an explicit loss function improves the transparency of inflation targeting and eliminates some misunderstandings of the meaning of ‘flexible’ inflation targeting. Using time-varying instrument-rate paths avoids a number of inconsistencies and other problems inherently associated with constant-interest-rate forecasts.

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File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=3365
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3365.

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Date of creation: May 2002
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Handle: RePEc:cpr:ceprdp:3365
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  1. Lars E.O. Svensson, 1999. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," NBER Working Papers 7276, National Bureau of Economic Research, Inc.
  2. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  3. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  4. Francisco J. Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," Banco de Espa�a Working Papers 0106, Banco de Espa�a.
  5. Persson, Torsten & Tabellini, Guido, 1997. "Political Economics and Macroeconomic Policy," CEPR Discussion Papers 1759, C.E.P.R. Discussion Papers.
  6. repec:sae:niesru:v:167:y::i:1:p:106-112 is not listed on IDEAS
  7. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  8. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
  9. Michael Woodford, 2001. "Inflation Stabilization and Welfare," NBER Working Papers 8071, National Bureau of Economic Research, Inc.
  10. Svensson, Lars E O & Woodford, Michael, 2004. "Implementing Optimal Policy Through Inflation-Forecast Targeting," CEPR Discussion Papers 4229, C.E.P.R. Discussion Papers.
  11. Nessen, Marianne & Vestin, David, 2005. "Average Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 837-63, October.
  12. Charles A.E. Goodhart, 2001. "Monetary transmission lags and the formulation of the policy decision on interest rates," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 165-186.
  13. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
  14. Leitemo, Kai, 2003. " Targeting Inflation by Constant-Interest-Rate Forecasts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 609-26, August.
  15. A. Robert Nobay & David A. Peel, 1998. "Optimal Monetary Policy in a Model of Asymmetric Central Bank Preferences," FMG Discussion Papers dp306, Financial Markets Group.
  16. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
  17. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March.
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