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Monetary Rules When Economic Behaviour Changes

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This paper examines the implications of changes in economic behaviour for simple inflation-forecast­based monetary rules of the type currently used at two inflation-targeting central banks. Three types of changes in economic behaviour are considered, changes that are motivated by developments in monetary and fiscal policy in the 1990s: changes in monetary policy credibility, changes in the slope of the Phillips curve, and changes in the degree of income stabilization from automatic fiscal transfers. Analysis is conducted using stochastic simulations of a model of the Canadian economy. Two questions are posed: First, what are the implications of these types of changes in economic behaviour for the stochastic properties of the economy? Second, how are efficient inflation-forecast­based rules affected by these changes in behaviour? Perhaps the most interesting results are with respect to credibility. When monetary credibility increases, the central bank can attain more stable output and inflation. But increasing credibility is a double-edged sword. To reap its benefits, the central bank must, in general, adjust its reaction function. If it does not, volatility can increase. Les auteurs examinent les conséquences des changements de comportement des agents économiques pour l'application de règles monétaires simples reposant sur la prévision de l'inflation, du genre de celles actuellement utilisées par deux banques centrales ayant établi des cibles en matière d'inflation. Ils analysent trois types de changement de comportement causés par l'évolution des politiques monétaire et budgétaire depuis le début des années 1990 : les changements de crédibilité de la politique monétaire, les variations de la pente de la courbe de Phillips et les modifications du degré de stabilisation automatique des revenus assuré par les paiements de transfert et les rentrées fiscales. L'analyse des auteurs se fonde sur l'exécution de simulations stochastiques au moyen d'un modèle de l'économie canadienne. Deux questions sont abordées. Premièrement, quelles sont les incidences de ces changements de comportement sur les propriétés stochastiques de l'économie? Deuxièmement, comment ces changements influent-ils sur une règle efficace de politique monétaire basée sur la prévision de l'inflation? Les résultats les plus intéressants de l'étude se situent probablement au chapitre de la crédibilité. Lorsque la crédibilité de la politique monétaire s'accroît, la banque centrale réussit mieux à atténuer les variations de la production et de l'inflation. Cependant, il s'agit là d'une arme à double tranchant. Pour jouir des avantages liés à une plus grande crédibilité, la banque centrale doit généralement modifier sa fonction de réaction : sinon, la volatilité peut augmenter au lieu de diminuer.

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  • Robert Amano & Don Coletti & Tiff Macklem, 1999. "Monetary Rules When Economic Behaviour Changes," Cahiers de recherche CREFE / CREFE Working Papers 81, CREFE, Université du Québec à Montréal.
  • Handle: RePEc:cre:crefwp:81
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    Cited by:

    1. Isard, Peter & Laxton, Douglas & Eliasson, Ann-Charlotte, 2001. "Inflation targeting with NAIRU uncertainty and endogenous policy credibility," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 115-148, January.
    2. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
    3. Nobay, A. R. & Peel, D. A., 2000. "Optimal monetary policy with a nonlinear Phillips curve," Economics Letters, Elsevier, vol. 67(2), pages 159-164, May.
    4. Yetman, James, 2003. "Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty," Journal of Macroeconomics, Elsevier, vol. 25(3), pages 311-330, September.
    5. Houda Ben Hadj Boubaker, 2011. "Inflation Forecast-Based Rule for Inflation Targeting: Case of Some Selected MENA Countries," Working Papers 628, Economic Research Forum, revised 09 Jan 2011.
    6. Robert A Buckle & Kunhong Kim & Nathan McLellan, 2003. "The impact of monetary policy on New Zealand business cycles and inflation variability," Treasury Working Paper Series 03/09, New Zealand Treasury.
    7. Pierre St-Amant & David Tessier, 2000. "Résultats empiriques multi-pays relatifs à l'impact des cibles d'inflation sur la crédibilité de la politique monétaire," Canadian Public Policy, University of Toronto Press, vol. 26(3), pages 295-310, September.
    8. Montes, Gabriel Caldas, 2013. "Credibility and monetary transmission channels under inflation targeting: An econometric analysis from a developing country," Economic Modelling, Elsevier, vol. 30(C), pages 670-684.
    9. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 143-160.
    10. Jean-Philippe Cayen & Simon van Norden, 2002. "La fiabilité des estimations de l'écart de production au Canada," Staff Working Papers 02-10, Bank of Canada.
    11. Yuong Ha, 2000. "Uncertainty about the length of the monetary policy transmission lag: implications for monetary policy," Reserve Bank of New Zealand Discussion Paper Series DP2000/01, Reserve Bank of New Zealand.
    12. Smets, Frank, 2000. "What horizon for price stability," Working Paper Series 0024, European Central Bank.
    13. International Monetary Fund, 2005. "Inflation Targeting and Output Growth; Empirical Evidence for the European Union," IMF Working Papers 05/89, International Monetary Fund.
    14. Montes, Gabriel Caldas & Tiberto, Bruno Pires, 2012. "Macroeconomic environment, country risk and stock market performance: Evidence for Brazil," Economic Modelling, Elsevier, vol. 29(5), pages 1666-1678.
    15. Gabriel Caldas Montes & Caroline Cabral Machado, 2013. "Credibility and the credit channel transmission of monetary policy theoretical model and econometric analysis for Brazil," Journal of Economic Studies, Emerald Group Publishing, vol. 40(4), pages 469-492, August.
    16. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
    17. Nicholas Apergis & Stephen M. Miller & Alexandros Panethimitakis & Athanassios Vamvakidis, 2005. "Inflation Targeting and Output Growth: Evidence from Aggregate European Data," Working papers 2005-06, University of Connecticut, Department of Economics.
    18. Jean-Philippe Cayen & Amy Corbett & Patrick Perrier, 2006. "An Optimized Monetary Policy Rule for ToTEM," Staff Working Papers 06-41, Bank of Canada.
    19. Perrier, Patrick, 1998. "Un examen de la crédibilité de la politique monétaire au Canada," Staff Working Papers 98-12, Bank of Canada.
    20. Jamie Armour & Ben Fung & Dinah Maclean, 2002. "Taylor Rules in the Quarterly Projection Model," Staff Working Papers 02-1, Bank of Canada.

    More about this item

    Keywords

    Monetary policy rules; credibility; Philipps curve; fiscal policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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