Inflation targeting Essay Example | Topics and Well Written Essays - 1750 words

Inflation targeting - Essay Example2% in the U.K. nd 2.5% in Nrwy. (Mishkin, Eakins, 2006) The difference between these frms des nt seem t mtter in prctice centrl bnk with trget rnge seems t im fr the middle f the rnge, nd the edges f the rnge re nrmlly interpreted s sft edges, in the sense tht they d nt trigger discrete plicy chnges nd beingness just utside the rnge is nt cnsidered much different frm being just inside.The relation between inflation targets and profound bank preferences has been thoroughly investigated. On one hand, there is a theoretical literature of Walsh (1995), Svensson (1997) that concludes that inflation targets can be used as a way of overcoming credibility problems because they can mimic optimal performance inducement contracts.On the other hand, there is an empirical literature (Bernanke et al. 1999), that looks whether inflation targets have been instrumental in reducing the policy-implied short-term trend rate of inflation. Broadly speaking, the indor se is that inflation targets have indeed brought about a change in policymakers inflation preferences. Unlike the relation between inflation targets and central bank preferences, a relatively underexplored issue is how to translate inflation targets into short-term interest rates. This is the issue of how to map explicit targets for monetary policy into monetary policy instruments, or how to apply an inflation-targeting framework. An exception is an important contribution by Svensson (1997). Svensson shows that because of lags in the transmission process of short-term interest rates to inflation, inflation targeting implies inflation forecast targeting. In his analysis, the central banks forecast becomes an explicit intermediate target and its optimal reaction function has the same form as the Taylor rule (1999). Bullard and Schaling (2001) augment the Svensson model with regime electric switch in productivity and calculate the optimal monetary policy rule in the altered environme nt. They find that a rule that incorporates leading indicators about regimes significantly outperforms the Taylor rule. They use this result to comment on the new economy events of the 1990s and the