Inflation Nutters? Modelling the Flexibility of Inflation Targeting
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Jan Libich
Opponents of explicit inflation targeting (including ex-Chairman Greenspan) have argued that a commitment to a numerical inflation target is likely to reduce monetary policy flexibility, and hence increase output volatility. Our paper demonstrates that this claim may fail to account for the anchoring effect of explicit targets on expectations and wages—found in the data by a number of empirical studies. We do so in a novel, dynamic game theoretic framework with asynchronous moves that endogenizes the frequency of the private sector’s actions. We derive the conditions under which an explicit long-term inflation target makes the behaviour of private agents rationally inattentive and anchored. This is through enhancing monetary policy credibility, which leads private agents to reconsider expectations and wages less frequently to minimize the cost of processing information and/or wage negotiations. Such anchoring makes the policymaker’s interest rate instrument more effective in stabilization, giving it greater leverage over the real rate. This implies that an explicit inflation target may improve the variability tradeoff, i.e. shift the policy frontier inwards. It can therefore make both inflation and output less variable in equilibrium, unlike what inflation targeting sceptics argue. We show that our results are consistent with existing empirical evidence, and discuss them in light of the global financial crisis. The policy implication is that the Federal Reserve, the Swiss National Bank, the Bank of Japan, and the European Central Bank should be more explicitly committed to a long-run inflation target.
©2011 Walter de Gruyter GmbH & Co. KG, Berlin/Boston
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- Trend Agnostic One-Step Estimation of DSGE Models
- Contributions Article
- Human Capital, Technology Adoption and Development
- Optimal Monetary Policy and Social Insurance in a Small Open Economy
- Estimated Interest Rate Rules: Do they Determine Determinacy Properties?
- Cyclical Upgrading of Labor and Employment Differences across Skill Groups
- Short-Run and Long-Run Effects of Banking in a New Keynesian Model
- Simple Analytics and Empirics of the Government Spending Multiplier and Other "Keynesian" Paradoxes
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- Economic Development and Heterogeneity in the Great Moderation among the States
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- The Quality of Public Investment
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- The "Elusive" Capital-User Cost Elasticity Revisited
- Asset Pricing and Housing Supply in a Production Economy
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- The Price of Egalitarianism
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- Cyclical Behavior of a Matching Model with Capital Investment
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- Slow-Moving Traps
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- Welfare Costs of Inflation and the Circulation of U.S. Currency Abroad
- Trade Liberalization, Competition and Growth
- The Dynamic Relationship between Inflation and Output Growth in a Cash-Constrained Economy
- Inflation Nutters? Modelling the Flexibility of Inflation Targeting
- Does Insurance Matter for Growth: Empirical Evidence from OECD Countries
- 28 Months Later: How Inflation Targeters Outperformed Their Peers in the Great Recession
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- Sector-Specific Markup Fluctuations and the Business Cycle: A Cross-Country Analysis
- External Debts and Current Account Adjustments
- Welfare Implications of Regional Asymmetries in a Monetary Union
- News Shocks and the External Finance Premium
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Articles in the same Issue
- Advances Article
- Trend Agnostic One-Step Estimation of DSGE Models
- Contributions Article
- Human Capital, Technology Adoption and Development
- Optimal Monetary Policy and Social Insurance in a Small Open Economy
- Estimated Interest Rate Rules: Do they Determine Determinacy Properties?
- Cyclical Upgrading of Labor and Employment Differences across Skill Groups
- Short-Run and Long-Run Effects of Banking in a New Keynesian Model
- Simple Analytics and Empirics of the Government Spending Multiplier and Other "Keynesian" Paradoxes
- Private Equity Premium and Aggregate Uncertainty in a Model of Uninsurable Investment Risk
- Economic Development and Heterogeneity in the Great Moderation among the States
- Social Security, Differential Fertility, and the Dynamics of the Earnings Distribution
- The Quality of Public Investment
- House Price Growth, Collateral Constraints and the Accumulation of Homeowner Debt in the United States
- The "Elusive" Capital-User Cost Elasticity Revisited
- Asset Pricing and Housing Supply in a Production Economy
- Fiscal Calculus and the Labor Market
- The Price of Egalitarianism
- Topics Article
- How Costly is CPI Inflation Targeting: A Two Sector Model with No Labor Mobility
- Cyclical Behavior of a Matching Model with Capital Investment
- The Cost Channel, Indeterminacy, and Price-Level versus Inflation Stabilization
- Monetary Policy Shocks and Risk Premia in the Interbank Market
- Slow-Moving Traps
- An Alternative Method for Measuring Financial Frictions
- Bubbles and Self-Fulfilling Crises
- Structural Breaks and the Fisher Effect
- Welfare Costs of Inflation and the Circulation of U.S. Currency Abroad
- Trade Liberalization, Competition and Growth
- The Dynamic Relationship between Inflation and Output Growth in a Cash-Constrained Economy
- Inflation Nutters? Modelling the Flexibility of Inflation Targeting
- Does Insurance Matter for Growth: Empirical Evidence from OECD Countries
- 28 Months Later: How Inflation Targeters Outperformed Their Peers in the Great Recession
- Time-Varying Returns, Intertemporal Substitution and Cyclical Variation in Consumption
- Micro-Data on Nominal Rigidity, Inflation Persistence and Optimal Monetary Policy
- How the Housing and Financial Wealth Effects Have Changed over Time
- Technology Shocks and Employment: Evidence from U.S. Firm-Level Data
- Monetary Policy Transmission under Zero Interest Rates: An Extended Time-Varying Parameter Vector Autoregression Approach
- Alternative Perspectives on Optimal Public Debt Adjustment
- Policy Distortions and Aggregate Productivity: The Role of Idiosyncratic Shocks
- Sector-Specific Markup Fluctuations and the Business Cycle: A Cross-Country Analysis
- External Debts and Current Account Adjustments
- Welfare Implications of Regional Asymmetries in a Monetary Union
- News Shocks and the External Finance Premium
- Interest Rates and Real Business Cycles in Emerging Markets
