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Inflation Range Targets with Hard Edges

A number of inflation targeting central banks operate under provisions that allow for increased flexibility when faced with large supply shocks. These so-called escape clauses, however, are usually hard to interpret and discretionary in nature. This paper argues that a practical and more viable option is to specify a hard edged target range. Within the range, the central bank enjoys complete independence. Should, however, a large supply shock force inflation outside the range, the government may overrule the bank unless it adjusts its policy to address the government's concerns. Such an arrangement has the advantage of being easily understood and non-discretionary. Furthermore, it is shown that the bandwidth of the target range is inversely related to the degree of flexibility of the inflation targeting regime and thus, provides an easy way for the central bank to communicate its preferences to the public. The paper also discusses various determinants of the optimal design of the target range.

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File URL: http://econ.hunter.cuny.edu/wp-content/uploads/sites/6/RePEc/papers/HunterEconWP423.pdf
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Paper provided by Hunter College Department of Economics in its series Economics Working Paper Archive at Hunter College with number 423.

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Date of creation: 2008
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Handle: RePEc:htr:hcecon:423
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  1. Stephen Cecchetti & Michael Ehrmann, 2000. "Does Inflation Targeting Increase Output volatility? An International Comparison of Policy Maker's Preferences and Outcomes," Working Papers Central Bank of Chile 69, Central Bank of Chile.
  2. Benjamin M. Friedman & Kenneth N. Kuttner, 1996. "A Price Target for U.S. Monetary Policy? Lessons from the Experience with Money Growth Targets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 77-146.
  3. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  4. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  5. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  6. Athey, Susan & Atkeson, Andrew & Kehoe, Patrick J., 2004. "The optimal degree of discretion in monetary policy," Working Paper Series 0338, European Central Bank.
  7. Laurence Ball & Niamh Sheridan, 2004. "Does inflation targeting matter?," DNB Staff Reports (discontinued) 118, Netherlands Central Bank.
  8. Robert Amano & Richard Black & Marcel Kasumovich, 1997. "A Band-Aid Solution to Inflation Targeting," Working Papers 97-11, Bank of Canada.
  9. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
  10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  11. Oscar Landerretche & Vittorio Corbo & Klaus Schmidt-Hebbel, 2001. "Does Inflation Targeting Make a Difference," Working Papers Central Bank of Chile 106, Central Bank of Chile.
  12. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  13. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  14. Christopher J. Erceg, 2002. "The Choice of an Inflation Target Range in a Small Open Economy," American Economic Review, American Economic Association, vol. 92(2), pages 85-89, May.
  15. Frederic S. Mishkin & Niklas J. Westelius, 2006. "Inflation Band Targeting and Optimal Inflation Contracts," NBER Working Papers 12384, National Bureau of Economic Research, Inc.
  16. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
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