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Inflation Targeting and the Dynamics of the Transmission Mechanism

  • Dillén, Hans


    (Monetary Policy Department, Central Bank of Sweden)

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    This paper derives closed-form expressions for optimal monetary policy rules when the central bank can influence inflation directly with a one-period lag as well as a two-period lagged effect via the output gap. It turns out that even a modest one-period inflation effect from monetary policy actions has substantial implications for monetary policy that also seem to be a step towards increased realism. For instance, in models where the central bank only can affect inflation with a two-period lag via the output gap, policy becomes more aggressive and the output gap exhibits a tendency to switch sign frequently. This unrealistic oscillating feature can be avoided by allowing the central bank to influence inflation with a one-period lag. The model also illustrates that the nature of empirical (or reduced-form) Phillips curves may reflect monetary policy and the observation that the Phillips curve in recent years has become flatter can in this model be explained by a more counter-cyclical monetary policy.

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    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 141.

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    Length: 17 pages
    Date of creation: 01 Sep 2002
    Date of revision: 01 Jul 2004
    Handle: RePEc:hhs:rbnkwp:0141
    Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
    Phone: 08 - 787 00 00
    Fax: 08-21 05 31
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    1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    2. Nessén, Marianne & Söderström, Ulf, 2000. "Core Inflation and Monetary Policy," Working Paper Series 110, Sveriges Riksbank (Central Bank of Sweden).
    3. Nessen, Marianne, 2002. "Targeting inflation over the short, medium and long term," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 313-329, September.
    4. Lindé, Jesper, 2001. "Estimating New-Keynesian Phillips Curves: A Full Information Maximum Likelihood Approach," Working Paper Series 129, Sveriges Riksbank (Central Bank of Sweden), revised 30 Apr 2001.
    5. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
    6. Lars E. O. Svensson, 1997. "Inflation Targeting: Some Extensions," NBER Working Papers 5962, National Bureau of Economic Research, Inc.
    7. Adolfson, Malin, 2001. "Monetary Policy with Incomplete Exchange Rate Pass-Through," SSE/EFI Working Paper Series in Economics and Finance 476, Stockholm School of Economics.
    8. Doyle, Matthew & Beaudry, Paul, 2000. "What Happened to the Phillips Curve in the 1990s in Canada," Staff General Research Papers 10286, Iowa State University, Department of Economics.
    9. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
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