Chapter

Implementing Optimal Policy through Inflation-Forecast Targeting

Lars E. O. Svensson and Michael Woodford

in The Inflation-Targeting Debate

Published by University of Chicago Press

Published in print February 2005 | ISBN: 9780226044712
Published online February 2013 | e-ISBN: 9780226044736 | DOI: http://dx.doi.org/10.7208/chicago/9780226044736.003.0003
Implementing Optimal Policy through Inflation-Forecast Targeting

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In recent years, many central banks have adopted inflation-targeting frameworks for the conduct of monetary policy. These have proven in a number of countries to be effective means of first lowering inflation and then maintaining both low and stable inflation and inflation expectations, without negative consequences for the output gap. It has been less clear how effective these procedures are as ways of bringing about desirable transitory fluctuations in inflation and output in response to exogenous shocks. This chapter considers how inflation targeting should be conducted in order to achieve optimal short-run responses to shocks. It first discusses the disadvantages of purely forward-looking policy making and then examines the extent to which various alternative forms of inflation targeting can avoid stabilization bias, incorporate history dependence of the proper sort, and result in determinacy of the equilibrium. It also discusses optimal equilibrium responses to shocks, interest rates in an optimal equilibrium, the problem of indeterminacy, and forecast targeting as an approach to dynamic optimization.

Keywords: inflation targeting; monetary policy; central banks; optimal equilibrium; shocks; interest rates; indeterminacy; forecast targeting; optimization; forward-looking policy making

Chapter.  31259 words. 

Subjects: Financial Markets

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