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Open-Economy Inflation Targeting

  • Svensson, Lars E.O.

    ()

    (Institute for International Economic Studies, Stockholm University)

The paper extends previous analysis of closed-economy inflation targeting to a small open economy with forward-looking aggregate supply and demand with some microfoundations, and with stylized realistic lags in the different transmission channels for monetary policy. The paper compares targeting of CPI and domestic inflation, strict and flexible inflation targeting, and inflation-targeting reaction functions and the Taylor rule. The optimal monetary policy response to several different shocks is examined. Flexible CPI-inflation targeting stands out as successful in limiting not only the variability of CPI inflation but also the variability of the output gap, and induce similar monetary policy responses. The model gives limited support for a so-called monetary conditions index, MCI, of the monetary-policy impact on aggregate demand, but the impact on inflation is too complex to be acptured by any single index. The index differs from currently used indices in combining (1) a long rather than a short real interest rate with the real exchange rate and (2) expected future values rather than current values. Because of (2), the index is not directly observable and verifiable to external observers.

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Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 638.

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Length: 51 pages
Date of creation: 21 Apr 1998
Date of revision:
Handle: RePEc:hhs:iiessp:0638
Contact details of provider: Postal: Institute for International Economic Studies, Stockholm University, S-106 91 Stockholm, Sweden
Phone: +46-8-162000
Fax: +46-8-161443
Web page: http://www.iies.su.se/

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  1. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
  2. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
  3. Haldane, Andrew G, 1998. "On Inflation Targeting in the United Kingdom," Scottish Journal of Political Economy, Scottish Economic Society, vol. 45(1), pages 1-32, February.
  4. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
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  7. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-34.
  8. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
  9. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
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  14. Cushman, David O. & Zha, Tao, 1997. "Identifying monetary policy in a small open economy under flexible exchange rates," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 433-448, August.
  15. Svensson, Lars E.O., 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Seminar Papers 615, Stockholm University, Institute for International Economic Studies.
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  17. Blake, Andrew P & Westaway, Peter F, 1996. "Credibility and the Effectiveness of Inflation Targeting Regimes," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(0), pages 28-50, Suppl..
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  21. Ray C. Fair & E. Philip Howrey, 1995. "Evaluating Alternative Monetary Policy Rules," Cowles Foundation Discussion Papers 1091, Cowles Foundation for Research in Economics, Yale University.
  22. David Mayes & Brendon Riches, 1996. "The effectiveness of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 59, March.
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