The Role of Inflation Target Adjustment in Stabilization Policy

59 Pages Posted: 25 Jun 2019

See all articles by Yunjong Eo

Yunjong Eo

The University of Sydney - School of Economics

Denny Lie

The University of Sydney - School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: June 18, 2019

Abstract

How and under what circumstances can adjusting the inflation target serve as a stabilization-policy tool and contribute to welfare improvement? We answer these questions quantitatively with a standard New Keynesian model that includes cost-push type shocks. Our proposed inflation target rule calls for the target to be adjusted in a persistent manner and in the opposite direction to the realization of a cost-push shock. The inflation target rule, combined with a Taylor-type rule, significantly reduces inflation fluctuations originating from cost-push shocks and mitigates the stabilization trade-off, resulting in a similar level of welfare to that associated with the Ramsey optimal policy.

Keywords: Cost-Push Shocks; Inflation-Output Trade-Off; Medium-Run Inflation Targeting; Welfare Analysis; Monetary Policy; Nominal Wage Rigidity; Capital Accumulation; Flat Phillips Curve

JEL Classification: E12; E32; E58; E61

Suggested Citation

Eo, Yunjong and Lie, Denny, The Role of Inflation Target Adjustment in Stabilization Policy (June 18, 2019). Available at SSRN: https://ssrn.com/abstract=3407988 or http://dx.doi.org/10.2139/ssrn.3407988

Yunjong Eo (Contact Author)

The University of Sydney - School of Economics ( email )

Social Sciences Building (A02)
Sydney, NSW 2006
Australia

Denny Lie

The University of Sydney - School of Economics ( email )

Rm 370 Merewether (H04)
Sydney, NSW 2006 2008
Australia

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