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Inflation Targets as Focal Points

  • Maria Demertzis

    (De Nederlandsche Bank and University of Amsterdam)

  • Nicola Viegi

    (University of KwaZulu-Natal)

In a world characterised by noisy information and conflicting signals, no Central Bank is always able to affect private sector expectations. Based on Morris and Shin's model, monetary policy then becomes an information game, in which individuals form their expectations based on all the information that is available to them (public and private). However individual agents also know that ultimately inflation is affected by both the objectives of the Central Bank (and hence the policies it pursues) as well as the average expectation formed by the all agents. They thus need to evaluate both actions. Central to our argument is the way that individuals interpret these actions to form their expectations. We apply Bacharach's methodology to provide a framework for assessing everyone's interpretations. Our contribution is to merge these two models to show that a monetary policy regime that has explicit quantitative objectives may provide individuals with better anchors for expectations to coordinate at. However, that is only true first, if no great shocks are anticipated to hit the economy and second, when all other public information is very unclear thus rendering the inflation target the only clear piece of information. We derive in detail the conditions under which this is true.

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Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2005 with number 52.

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Date of creation: 03 Sep 2005
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Handle: RePEc:mmf:mmfc05:52
Contact details of provider: Web page: http://www.essex.ac.uk/afm/mmf/index.html

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  1. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  2. Antulio N. Bomfim & Glenn D. Rudebusch, 1997. "Opportunistic and deliberate disinflation under imperfect credibility," Working Papers in Applied Economic Theory 97-07, Federal Reserve Bank of San Francisco.
  3. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  4. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  5. Jeffery D. Amato & Hyun Song Shin, 2004. "Public and Private Information in Monetary Policy Models," DNB Staff Reports (discontinued) 117, Netherlands Central Bank.
  6. Christopher R. Knittel & Victor Stango, 2001. "Price ceilings as focal points for tacit collusion: evidence from credit cards," Working Paper Series WP-01-12, Federal Reserve Bank of Chicago.
  7. Jeffery D. Amato & Hyun Song Shin & Stephen Morris, 2003. "Communication and monetary policy," BIS Working Papers 123, Bank for International Settlements.
  8. Andrew T. Levin & Fabio M. Natalucci & Jeremy M. Piger, 2004. "The macroeconomic effects of inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 51-80.
  9. Sugden, Robert, 1995. "A Theory of Focal Points," Economic Journal, Royal Economic Society, vol. 105(430), pages 533-50, May.
  10. George-Marios Angeletos & Alessandro Pavan, 2007. "Efficient Use of Information and Social Value of Information," Econometrica, Econometric Society, vol. 75(4), pages 1103-1142, 07.
  11. Fatás, Antonio & Mihov, Ilian & Rose, Andrew K., 2006. "Quantitative goals for monetary policy," Working Paper Series 0615, European Central Bank.
  12. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  13. M. Demertzis & N. Viegi, 2004. "Aiming for the Bull's Eye: Inflation Targeting under Uncertainty," DNB Staff Reports (discontinued) 88, Netherlands Central Bank.
  14. Paloviita , Maritta & Virén , Matti, 2005. "The role of expectations in the inflation process in the euro area," Research Discussion Papers 6/2005, Bank of Finland.
  15. Casajus, Andre, 2000. "Focal Points in Framed Strategic Forms," Games and Economic Behavior, Elsevier, vol. 32(2), pages 263-291, August.
  16. Stephen Morris & Hyun S Shin, 2001. "Global Games: Theory and Applications," Levine's Working Paper Archive 122247000000001080, David K. Levine.
  17. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November.
  18. Jon Faust & Dale W. Henderson, 2004. "Is inflation targeting best-practice monetary policy?," International Finance Discussion Papers 807, Board of Governors of the Federal Reserve System (U.S.).
  19. Andrew Hallett & Nicola Viegi, 2002. "Inflation Targeting as a Coordination Device," Open Economies Review, Springer, vol. 13(4), pages 341-362, October.
  20. Glenn D. Rudebusch & John C. Williams, 2006. "Revealing the secrets of the temple: the value of publishing central bank interest rate projections," Working Paper Series 2006-31, Federal Reserve Bank of San Francisco.
  21. Maarten Janssen, 2001. "Rationalizing Focal Points," Theory and Decision, Springer, vol. 50(2), pages 119-148, March.
  22. Leitemo, Kai, 2008. "Inflation-targeting rules: History-dependent or forward-looking?," Economics Letters, Elsevier, vol. 100(2), pages 267-270, August.
  23. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One decade of inflation targeting in the world : What do we know and what do we need to know?," Working Papers Central Bank of Chile 101, Central Bank of Chile.
  24. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  25. Kenneth N. Kuttner, 2004. "The role of policy rules in inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 89-112.
  26. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
  27. Johnson, David R., 2002. "The effect of inflation targeting on the behavior of expected inflation: evidence from an 11 country panel," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1521-1538, November.
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