Working Paper: CEPR ID: DP4229
Authors: Lars E. O. Svensson; Michael Woodford
Abstract: We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.
Keywords: commitment; discretion; inflation targeting
JEL Codes: E42; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation-forecast targeting (E31) | avoid stabilization bias (C62) |
| inflation-forecast targeting (E31) | improve short-run trade-offs between inflation stabilization and output-gap stabilization (E63) |
| history-dependence of policy responses (E65) | alignment of private sector expectations with central bank's objectives (E61) |
| inflation-forecast targeting (E31) | determinacy of equilibrium (C62) |
| targeting rule incorporating feedback from endogenous variables (C51) | render equilibrium determinate (D50) |
| commitment to targeting rule (E61) | enhance transparency and accountability (G38) |
| enhanced transparency and accountability (G38) | reinforce effectiveness of inflation-forecast targeting (E61) |