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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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    File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2000/dp00_8.pdf
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    Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2000/08.

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    Length: 28p
    Date of creation: Apr 2000
    Date of revision:
    Handle: RePEc:nzb:nzbdps:2000/08
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    Phone: 64 4 471-3767
    Fax: 64 4 471-2270
    Web page: http://www.rbnz.govt.nzEmail:


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    4. Drew, Aaron & Hunt, Benjamin, 2000. "Efficient simple policy rules and the implications of potential output uncertainty," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 143-160.
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    8. Orphanides, Athanasios, 1999. "The Quest for Prosperity Without Inflation," Working Paper Series 93, Sveriges Riksbank (Central Bank of Sweden).
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    11. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc.
    12. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
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    15. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," Working Papers 97-32, C.V. Starr Center for Applied Economics, New York University.
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    18. Iris Claus, 2003. "Estimating potential output for New Zealand," Applied Economics, Taylor & Francis Journals, vol. 35(7), pages 751-760.
    19. Iris Claus, 2000. "Is the output gap a useful indicator of inflation?," Reserve Bank of New Zealand Discussion Paper Series DP2000/05, Reserve Bank of New Zealand.
    20. Arturo Estrella & Frederic S. Mishkin, 1999. "Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 405-436 National Bureau of Economic Research, Inc.
    21. Athanasios Orphanides & Richard D. Porter & David Reifschneider & Robert Tetlow & Frederico Finan, 1999. "Errors in the measurement of the output gap and the design of monetary policy," Finance and Economics Discussion Series 1999-45, Board of Governors of the Federal Reserve System (U.S.).
    22. David Hargreaves, 1999. "SDS-FPS: a small demand-side version of the Forecasting and Policy System core model," Reserve Bank of New Zealand Discussion Paper Series G99/10, Reserve Bank of New Zealand.
    23. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 1999 841, Society for Computational Economics.
    24. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    25. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
    26. Aaron Drew & Ben Hunt, 1998. "The Forecasting and Policy System: stochastic simulations of the core model," Reserve Bank of New Zealand Discussion Paper Series G98/6, Reserve Bank of New Zealand.
    27. Paul Conway & David Frame, 2000. "A spectral analysis of New Zealand output gaps using Fourier and wavelet techniques," Reserve Bank of New Zealand Discussion Paper Series DP2000/06, Reserve Bank of New Zealand.
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