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Inflation Target Instability and Interest Rates

  • Mellin, Stefan

    (Dept. of Economics, Stockholm University)

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    The implementation of explicit quantitative inflation targets elucidates the assessment of credibility of future monetary policy. Here the explicit inflation target is time-varying and stochastic with asymmetric information. It is shown that central bank independence promotes lower inflation but not at the cost of increased output variability. Marked political instability and instrument dependence are detrimental to credibility, and impede monetary policy with unchanged long term nominal interest rates. The marginal effect from less independence on interest rate volatility is increasing in political instability. Strategic delegation of an optimal inflation target with a monetary reform eliminates the inflation bias. Empirical evidence substantiates the predictions when confronted with cross-country OECD data.

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    Paper provided by Stockholm University, Department of Economics in its series Research Papers in Economics with number 1997:4.

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    Length: 31 pages
    Date of creation: 02 Jun 1998
    Date of revision:
    Handle: RePEc:hhs:sunrpe:1997_0004
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    Department of Economics, Stockholm, S-106 91 Stockholm, Sweden

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