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Inflation Targets as Focal Points

  • Maria Demertzis
  • Nicola Viegi

The benefits of inflation targeting by comparison to alternative regimesare understood to be in terms of providing clearer objectives that help pin down private sector expectations in the long run. We argue that the mechanism for achieving this rests on the fact that monetary policy can be perceived as a matching game in which private agents aim to coordinate their expectations and thus benefit from a clearly given signal that acts as a focal point. We therefore, argue that first, the credibility of the signal achieves coordination and second that the clarity of the signal achieves welfare improvements. To demonstrate that we use Bacharach's, Variable Universe Game framework, which allows for individuals' understanding and interpretation of the signal to differ. As private agents benefit from coordination, they rely a lot on the public signal given. Following this, the Central Bank can then help increase the welfare of agents by providing clear and precise signal that increase the chance of coordination and hence increased welfare.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 017.

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Date of creation: Nov 2004
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Handle: RePEc:dnb:dnbwpp:017
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