Inflation Targeting During Asset and Commodity Price Booms

Posted: 24 May 2010

See all articles by Nicoletta Batini

Nicoletta Batini

International Monetary Fund (IMF)

Eugen Tereanu

World Bank

Abstract

The recent global economic crisis originated in the midst of a commodity price boom that had triggered sharp increases in inflation in many world countries. The crisis also came in the context of a rally in asset prices and large domestic imbalances in the United States. This paper uses a small open-economy dynamic stochastic general equilibrum (DSGE) model to design the correct monetary policy response to a protracted supply shock, and examines how that response would change when many become credit constrained - like in a credit crunch - and when spending of those who can still borrow becomes very sensitive to the interest rate because of over-leveraging. Using a version of the model with Kalman learning, the paper also evaluates the implications of a loss of target credibility, showing how rules must be adjusted when the authorities’ commitment to the inflation target has been eroded. The appropriate response to future evolutions of the price of oil, including to large downward corrections from the current level, is also evaluated.

Keywords: inflation targeting, oil prices, asset prices, supply shock, bubble, optimal horizon, monetary policy rules

JEL Classification: E37, E52, E58

Suggested Citation

Batini, Nicoletta and Tereanu, Eugen, Inflation Targeting During Asset and Commodity Price Booms. Oxford Review of Economic Policy, Vol. 26, No. 1, pp. 15-35, 2010. Available at SSRN: https://ssrn.com/abstract=1612635 or http://dx.doi.org/grp032

Nicoletta Batini (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Eugen Tereanu

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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