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Aiming for the Bull's Eye: Inflation Targeting under Uncertainty

  • M. Demertzis
  • N. Viegi

We study the implications of uncertainty for ination targeting. We apply Brainard's static framework which imposes multiplicative uncertainty in the monetary transmission. Brainard's main result is that in the presence of uncertainty, monetary authorities become naturally more cautious. But this also implies that monetary objectives are seldom achieved. We there- fore attempt next to ...nd a monetary rule that reaches the objectives set more often, improving therefore the welfare of the Central Bank. Such a rule is the result of a new algorithm that we put forward, in which the ination target is state contigent. The Central Bank sets (as an auxil- liary step) therefore, a variable ination target that depends optimally, on both the degree of uncertainty as well as on the shocks that occur each time. We show that such a rule helps the CB attain its objectives more often thereby reducing the losses incurred. Moreover, and as a corollary to such an approach, the rule derived is ex ante neutral to the degree of uncertainty.

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File URL: http://www.dnb.nl/en/binaries/wo0671_tcm47-145972.pdf
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Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 88.

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Length: 18 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:dnb:staffs:88
Contact details of provider: Postal: Postbus 98, 1000 AB Amsterdam
Web page: http://www.dnb.nl/en/

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  1. Hughes Hallett, Andrew J, 1989. "Econometrics and the Theory of Economic Policy: The Tinbergen-Theil Contributions 40 Years On," Oxford Economic Papers, Oxford University Press, vol. 41(1), pages 189-214, January.
  2. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August.
  3. Geraats, Petra M., 2001. "Why adopt transparency? The publication of central bank forecasts," Working Paper Series 0041, European Central Bank.
  4. Faust, J. & Svensson, L.E.O., 1998. "Transparency and Credibility: Monetary Policy with Unobservable Goals," Papers 636, Stockholm - International Economic Studies.
  5. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  6. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
  7. Lewis, Karen K, 1991. "Why Doesn't Society Minimize Central Bank Secrecy?," Economic Inquiry, Western Economic Association International, vol. 29(3), pages 403-15, July.
  8. Frederic S. Mishkin & Adam S. Posen, 1998. "Inflation Targeting: Lessons from Four Countries," NBER Working Papers 6126, National Bureau of Economic Research, Inc.
  9. Glenn D. Rudebusch & Carl E. Walsh, 1998. "U.S. inflation targeting: pro and con," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may29.
  10. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
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