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Inflation Targeting: a Framework for Communication

Listed author(s):
  • Maria Demertzis
  • Nicola Viegi

More than a monetary policy strategy, we interpret inflation targeting as a framework for communication. We model monetary policy as an information game between the Bank and private agents. Our analysis shows how the provision of an explicit numerical inflation objective overcomes potential information imperfections by providing a focal point for agents who form expectations. Furthermore, the combination of the target and the tolerance bands around it communicated, provide a very clear framework with which to evaluate monetary policy outcomes. A successful Central Bank then builds up credibility and a credible Central Bank is in a better position to be successful in subsequent periods. We show how (and when) inflation targeting exploits this self-reinforcing loop to help the Central Bank endure large and long-lasting shocks. Last, we show that a trade-off emerges when choosing the band-width: too narrow bands provide a focal point but reduce the likelihood of inflation being ‘successful’. Too wide bands on the other hand, lead easier to success but at the risk of failing to provide a clear focal point. We thus derive the optimal band-width for different scenarios.

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File URL: http://www.econrsa.org/node/96
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Paper provided by Economic Research Southern Africa in its series Working Papers with number 71.

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Date of creation: 2008
Handle: RePEc:rza:wpaper:71
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  3. Maria Demertzis & Nicola Viegi, 2008. "Inflation Targets as Focal Points," International Journal of Central Banking, International Journal of Central Banking, vol. 4(1), pages 55-87, March.
  4. Giuseppe Moscarini, 2007. "Competence Implies Credibility," American Economic Review, American Economic Association, vol. 97(1), pages 37-63, March.
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  7. Frederic S. Miskin & Klaus Schmidt-Hebbel, 2007. "Does Inflation Targeting Make a Difference?," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 9, pages 291-372 Central Bank of Chile.
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  15. Frederic S. Mishkin & Niklas J. Westelius, 2008. "Inflation Band Targeting and Optimal Inflation Contracts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 557-582, 06.
  16. King, Robert G. & Wolman, Alexander L., 2004. "Monetary discretion, pricing complementarity and dynamic multiple equilibria," Working Paper Series 343, European Central Bank.
  17. Alan S. Blinder, 2000. "Central-Bank Credibility: Why Do We Care? How Do We Build It?," American Economic Review, American Economic Association, vol. 90(5), pages 1421-1431, December.
  18. 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.
  19. 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.
  20. Bomfim, Antulio N & Rudebusch, Glenn D, 2000. "Opportunistic and Deliberate Disinflation under Imperfect Credibility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 707-721, November.
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