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inflation targeting economic discussion

Moreover, this mechanism would make it feasible for trend inflation to be lowered, which would bring additional benefits.

But price-level targeting did not take-off; it has not been adopted by a major central bank since.In recent years, however, economists have re-assessed the merits of price-level targeting in the light of new research and better models.Consider, for instance, a situation where the economy has been hit by a large negative shock to aggregate demand, and nominal interest rates have been cut to zero in an attempt to stimulate the economy back to full capacity.

(2008), “Optimal and simple monetary policy rules with zero floor on the nominal interest rate”, Smets, F. and Wouters, R. (2007), “Shocks and frictions in US business cycles: a Bayesian DSGE approach”, Smith, A.A. Jr. (1993), “Estimating nonlinear time-series models using simulated vector autoregressions”, 2 Positive trend inflation has three distinct costs in New Keynesian models (see Ambler 2007). The behavioural expectations are the weighted average of a ‘fundamentalist’ forecasting rule, in which the output gap or inflation are forecasts at their steady state values, and a rule extrapolating the most recent value. If you are a registered author of this item, you may also want to check the "citations" tab in your This column reviews a survey on the merits of price-level targeting. Eggertsson, G.B. When requesting a correction, please mention this item's handle: So, the comparison is pertinent for them. Thus, if the inflation projection is above the target, monetary policy has to become tighter, and vice versa. Many policymakers have considered such behavioural rules to be probable and have had doubts about the ‘strong’ rational expectations assumption. Such beneficial effects depend on rational expectations and a New Keynesian structure of the economy. (2005) and Smets and Wouters (2007) show that New Keynesian models can match key dynamic features of US data and perform impressively in out-of-sample forecast tests. inflation targeting during the 1990s and thirteen that did not. More recently, Coibion et al. For instance, Christiano et al. The traditional welfare cost due to inflation acting as a tax on money holdings (see Bailey 1956) is not one of them. After the demand shock has hit and inflation falls below 2%, a credible price-level target would create the expectation of future inflation of more than 2%. by the model ratio of consumption to GDP of 0.8.3 We provide a brief discussion of the pros and cons of survey and experimental evidence in Hatcher and Minford (2014). Since there are additional welfare gains associated with a lower trend rate of inflation, the potential welfare gains from price-level targeting are much larger and amount to 0.4% of GDP per year.Covas and Zhang (2010) and Bailliu et al. It is important to note, however, that this mechanism rests crucially on the assumption that the price-level target is credible. Because the central bank is obliged to offset past inflationary shocks in this way, targeting prices is ‘history dependent’ (Woodford 2003). Usefully for our focus here, they tested the model under both rational expectations and behavioural expectations as in De Grauwe (2010). Downloadable!

On average, however, there is no evidence that inflation targeting improves performance as measured by the behav-ior of inflation, output, or interest rates. With real interest rates either constant or rising, a lengthy recession is likely to ensue.Targeting the price level leads to a different dynamic for inflation expectations. (2012), “Macroprudential rules and monetary policy when financial frictions matter”, Bank of Canada Working Paper 2012-6.Berg, C., Jonung, L. (1999), “Pioneering price-level targeting: the Swedish experience 1931-1937”,Canova, F., Sala, L. (2009), “Back to square one: Identification issues in DSGE models”, Christiano, L.J., Eichenbaum, M.S., Evans, C.L. By contrast, inflation targeting aims for average (i.e. When inflation unexpectedly rises to 3% in period 3, rational households and firms will anticipate future inflation of 2% in periods 4 and 5. Price stability is the key goal of almost every central bank in the world. Such beneficial effects depend on rational expectations and a New Keynesian structure of the economy. Not surpris-ingly, economic performance varies greatly across individual countries, both targeters and nontargeters.

Bank of Jamaica Inflation-Targeting Dubplate for 2020 Subscribe to email updates from the tutor2u Economics Join 1000s of fellow Economics teachers and students all getting the tutor2u Economics team's latest resources and support delivered fresh in their inbox every morning. For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Research-based policy analysis and commentary from leading economists This expectations mechanism has additional bite in New Keynesian models because an increase in expected inflation raises current inflation, and higher output expectations raise aggregate demand.Both Eggertsson and Woodford (2003) and Nakov (2008) confirm this intuition. Google Scholar

and Woodford, M. (2003), “The zero bound on interest rates and optimal monetary policy”, Fair, R.C. If you have authored this item and are not yet registered with RePEc, we encourage you to do it 1 This Discussion Paper is the text of a public lecture held at Victoria University of Wellington, New ... economy, meet the inflation target at an appropriate horizon.

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