Inflation Targeting Under Imperfect Policy Credibility

32 Pages Posted: 3 May 2009

See all articles by Ali Alichi

Ali Alichi

International Monetary Fund (IMF)

Huigang Chen

International Monetary Fund (IMF)

Kevin Clinton

Government of Canada - Bank of Canada

Charles Freedman

Government of Canada - Bank of Canada; National Bureau of Economic Research (NBER)

Marianne Johnson

Independent

Ondra Kamenik

International Monetary Fund (IMF)

Turgut Kisinbay

International Monetary Fund (IMF)

Douglas Laxton

International Monetary Fund (IMF) - Research Department

Date Written: April 2009

Abstract

This paper presents a model for Inflation Targeting under imperfect policy credibility. It modifies the conventional model in three ways: an endogenous policy credibility process, by which monetary policy can gain or lose credibility over time; non-linearities in the inflation equation and in the credibility generating process; and an explicit loss function. The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets. Also, unfavorable supply shocks pose a difficult problem: an appropriate response involves an interest rate increase, some loss of output, and a period of increased inflation. A delayed response can result in a prolonged period of stagflation.

Keywords: Inflation targeting, Emerging markets, Monetary policy, Disinflation, Demand, Price increases, Economic models

Suggested Citation

Alichi, Ali and Chen, Huigang and Clinton, Kevin and Freedman, Charles and Johnson, Marianne and Kamenik, Ondra and Kisinbay, Turgut and Laxton, Douglas, Inflation Targeting Under Imperfect Policy Credibility (April 2009). IMF Working Paper No. 09/94, Available at SSRN: https://ssrn.com/abstract=1397924

Ali Alichi

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Huigang Chen

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Kevin Clinton

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada
613-782-8766 (Phone)
613-782 7508 (Fax)

Charles Freedman

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ontario K1A 0G9
Canada
613 782-8045 (Phone)
613 782-7003 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Marianne Johnson

Independent ( email )

Ondra Kamenik (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Turgut Kisinbay

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Douglas Laxton

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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