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Monetary Rules When Economic Behaviour Changes

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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Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 81.

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Length: 51 pages
Date of creation: May 1999
Date of revision:
Handle: RePEc:cre:crefwp:81
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