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The Inflation Bias When the Central Bank Targets, the Natural Rate of Unemployment

  • RUGE-MURCIA, Francisco J.

This paper studies the proposition that an inflation bias can arise in a setup where a central banker with asymmetric preferences targets the natural unemployment rate. Preferences are asymmetric in the sense that positive unemployment deviations from the natural rate are weighted more (or less) severely than negative deviations in the central banker's loss function. The bias is proportional to the conditional variance of unemployment. The time-series predictions of the model are evaluated using data from G7 countries. Econometric estimates support the prediction that the conditional variance of unemployment and the rate of inflation are positively related.

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Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 2001-22.

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Length: 23 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:mtl:montde:2001-22
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  1. Dolado, Juan J. & María-Dolores, Ramón & Naveira Barrero, Manuel, 2000. "Asymmetries In Monetary Policy Rules: Evidence For Four Central Banks," CEPR Discussion Papers 2441, C.E.P.R. Discussion Papers.
  2. Francisco J. Ruge-Murciá, 2002. "A Prudent Central Banker," IMF Staff Papers, Palgrave Macmillan, vol. 49(3), pages 7.
  3. Persson, Torsten & Tabellini , Guido, 1997. "Political Economics and Macroeconomic Policy," Seminar Papers 630, Stockholm University, Institute for International Economic Studies.
  4. A. Robert Nobay & David A. Peel, 1998. "Optimal Monetary Policy in a Model of Asymmetric Central Bank Preferences," FMG Discussion Papers dp306, Financial Markets Group.
  5. 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.
  6. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  7. Hamilton, James D., 1996. "This is what happened to the oil price-macroeconomy relationship," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 215-220, October.
  8. 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.
  9. Alex Cukierman, 2002. "Are contemporary central banks transparent about economic models and objectives and what difference does it make?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 15-36.
  10. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, June.
  11. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  12. Mervyn King, 1996. "How should central banks reduce inflation? - Conceptual issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 25-52.
  13. Jonathan S. Skinner, 1987. "Risky Income, Life Cycle Consumption, and Precautionary Savings," NBER Working Papers 2336, National Bureau of Economic Research, Inc.
  14. Pagan, Adrian & Ullah, Aman, 1988. "The Econometric Analysis of Models with Risk Terms," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 3(2), pages 87-105, April.
  15. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  16. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
  17. RUGE-MURCIA, Francisco J., 2001. "The Inflation Bias When the Central Bank Targets, the Natural Rate of Unemployment," Cahiers de recherche 2001-22, Universite de Montreal, Departement de sciences economiques.
  18. Nobay, A. R. & Peel, D. A., 2000. "Optimal monetary policy with a nonlinear Phillips curve," Economics Letters, Elsevier, vol. 67(2), pages 159-164, May.
  19. Cukierman, A., 1999. "The Inflation Bias Result Revisited," Papers 38-99, Tel Aviv.
  20. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  21. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
  22. Broadbent, Ben & Barro, Robert J., 1997. "Central bank preferences and macroeconomic equilibrium," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 17-43, June.
  23. Mervyn King, 1996. "How should central banks reduce inflation? conceptual issues," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 53-91.
  24. Lockwood, Ben & Philippopoulos, Apostolis, 1994. "Insider Power, Unemployment Dynamics and Multiple Inflation Equilibria," Economica, London School of Economics and Political Science, vol. 61(241), pages 59-77, February.
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