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Inflation targeting under potential output uncertainty

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In this paper, measures of the uncertainty surrounding estimates of New Zealand's potential output are used to consider whether the output gap is a useful concept for the monetary authority to base policy actions on. The analysis relies on stochastic simulations of the Reserve Bank of New Zealand's Forecasting and Policy System macroeconomic model (FPS). The analysis shows that when the policymakers' estimates of the output gap have large serially correlated errors that are positively correlated with the business cycle, both output and inflation become more variable. However, the output gap is still useful for stabilising output and inflation. Basing policy actions on the output gap directly and/or indirectly through forecasts of inflation leads to better macroeconomic stability than basing policy actions solely on currently available observable data such as inflation and output growth.

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  • Victor Gaiduch & Benjamin Hunt, 2000. "Inflation targeting under potential output uncertainty," Reserve Bank of New Zealand Discussion Paper Series DP2000/08, Reserve Bank of New Zealand.
  • Handle: RePEc:nzb:nzbdps:2000/08
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    Cited by:

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    2. Hunt, Benjamin & Laxton, Douglas, 2004. "The Zero Interest Rate Floor (ZIF) and its Implications for Monetary Policy in Japan," National Institute Economic Review, Cambridge University Press, vol. 187, pages 76-92, January.
    3. Gonzalo Llosa & Shirley Miller, 2004. "Using Additional Information in Estimating the Output Gap in Peru: a Multivariate Unobserved Component Approach," Money Affairs, Centro de Estudios Monetarios Latinoamericanos, CEMLA, vol. 0(1), pages 57-82, January-J.
    4. Nadia Saleem, 2010. "Adopting Inflation Targeting in Pakistan: An Empirical Analysis," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 15(2), pages 51-76, Jul-Dec.
    5. L Christopher Plantier & Dean Scrimgeour, 2002. "Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate," Reserve Bank of New Zealand Discussion Paper Series DP2002/06, Reserve Bank of New Zealand.
    6. Jean-Philippe Cayen & Simon van Norden, 2002. "La fiabilité des estimations de l'écart de production au Canada," Staff Working Papers 02-10, Bank of Canada.

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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