The Role of Short-Run Inflation Targets and Forecasts in Disinflation

Bank of England Working Paper No. 167

40 Pages Posted: 14 May 2003

See all articles by Lavan Mahadeva

Lavan Mahadeva

Bank of England - Monetary Analysis

Gabriel Sterne

Bank of England

Date Written: October 2002

Abstract

Globally, the majority of countries using inflation targets have done so when inflation was neither low nor stable. Many such countries have changed their target each year, and our empirical estimates support theoretical predictions that annual changes to the target are endogenous to outcomes. We use a unique cross-country panel dataset of inflation targets and outcomes in 60 countries in the 1990s. Our estimates suggest the target revision may be predicted according to a simple 'forecasting' rule, and depends upon the outcome's deviation from both the short-run and long-run target. During disinflation, policy-makers may therefore be characterised as using two types of policy rule; one for setting interest rates, the other for revising annual targets. In designing roles for the legislator and the central bank in the monetary framework, it is necessary to take into account the likelihood that the process of setting the target may, in some circumstances, be inseparable from that of setting policy instruments. In the light of other literature, we also argue that during disinflation, short-run targets may help central banks to build credibility because they may increase transparency.

Suggested Citation

Mahadeva, Lavan and Sterne, Gabriel, The Role of Short-Run Inflation Targets and Forecasts in Disinflation (October 2002). Bank of England Working Paper No. 167. Available at SSRN: https://ssrn.com/abstract=392280 or http://dx.doi.org/10.2139/ssrn.392280

Lavan Mahadeva

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Gabriel Sterne (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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