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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
Handle: RePEc:htr:hcecon:423
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  1. Frederic S. Mishkin & Niklas J. Westelius, 2006. "Inflation Band Targeting and Optimal Inflation Contracts," NBER Working Papers 12384, National Bureau of Economic Research, Inc.
  2. Laurence Ball & Niamh Sheridan, 2003. "Does Inflation Targeting Matter?," NBER Working Papers 9577, National Bureau of Economic Research, Inc.
  3. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
  4. Frederic S. Mishkin, 2007. "Monetary Policy Strategy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262134829.
  5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  6. Robert Amano & Richard Black & Marcel Kasumovich, 1997. "A Band-Aid Solution to Inflation Targeting," Staff Working Papers 97-11, Bank of Canada.
  7. Athey, Susan & Atkeson, Andrew & Kehoe, Patrick J., 2004. "The optimal degree of discretion in monetary policy," Working Paper Series 0338, European Central Bank.
  8. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  9. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  10. Vittorio Corbo & Óscar Landerretche & Klaus Schmidt-Hebbel, 2002. "Does Inflation Targeting Make a Difference?," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.), Inflation Targeting: Desing, Performance, Challenges, edition 1, volume 5, chapter 5, pages 221-270 Central Bank of Chile.
  11. 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.
  12. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-167, March.
  13. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  14. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
  15. 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.
  16. 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 473-491, June.
  17. JoAnne Morris & Tonny Lybek, 2004. "Central Bank Governance; A Survey of Boards and Management," IMF Working Papers 04/226, International Monetary Fund.
  18. Benjamin M. Friedman & Kenneth N. Kuttner, 1996. "A price target for U.S. monetary policy? Lessons from the experience with money growth targets," Working Paper Series, Macroeconomic Issues WP-96-14, Federal Reserve Bank of Chicago.
  19. King, Mervyn, 1997. "Changes in UK monetary policy: Rules and discretion in practice," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 81-97, June.
  20. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
  21. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-286, March.
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