Chapter

Optimal Inflation-Targeting Rules

Marc P. Giannoni 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/9780226044736.003.0004
Optimal Inflation-Targeting Rules

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An increasingly popular approach to the conduct of monetary policy, since the early 1990s, has been inflation-forecast targeting. Under this general approach, a central bank is committed to adjust short-term nominal interest rates periodically so as to ensure that its projection for the economy's evolution satisfies an explicit target criterion. One benefit that is claimed for such an approach—and an important advantage, at least in principle, of inflation targeting over other policy rules—is the possibility of combining reasonable stability of the inflation rate (especially over the medium to long term) with optimal short-run responses to real disturbances of various sorts. This chapter shows that it is possible to derive robustly optimal monetary policy rule for optimizing models of the monetary transmission mechanism that incorporate a number of common features of recent empirical models: staggered wage- and price-setting; inflation inertia resulting from automatic indexation of wages and prices to a lagged price index; predetermined wage-setting, pricing, and spending decisions; and habit persistence in the level of real private expenditure.

Keywords: inflation targeting; monetary policy; monetary transmission mechanism; inflation inertia; wages; prices; habit persistence; interest rates

Chapter.  31523 words.  Illustrated.

Subjects: Financial Markets

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