Inflation Targets as Focal Points

Bank of the Netherlands Working Paper No. 17

26 Pages Posted: 2 Nov 2005

See all articles by Maria Demertzis

Maria Demertzis

Bruegel

Nicola Viegi

University of Pretoria - Department of Economics

Date Written: September 30, 2005

Abstract

In a world characterised by noisy information and conflicting signals, no Central Bank is always able to affect private sector expectations. Based on Morris and Shin's model, monetary policy then becomes an information game, in which individuals form their expectations based on all the information that is available to them (public and private). However individual agents also know that ultimately inflation is affected by both the objectives of the Central Bank (and hence the policies it pursues) as well as the average expectation formed by the all agents. They thus need to evaluate both actions. Central to our argument is the way that individuals interpret these actions to form their expectations. We apply Bacharach's methodology to provide a framework for assessing everyone's interpretations. Our contribution is to merge these two models to show that a monetary policy regime that has explicit quantitative objectives may provide individuals with better anchors for expectations to coordinate at. However, that is only true first, if no great shocks are anticipated to hit the economy and second, when all other public information is very unclear thus rendering the inflation target the only clear piece of information. We derive in detail the conditions under which this is true.

Keywords: Inflation Targeting,Information Games,Matching Games,Focal Points

JEL Classification: C71, C78, E52

Suggested Citation

Demertzis, Maria and Viegi, Nicola, Inflation Targets as Focal Points (September 30, 2005). Available at SSRN: https://ssrn.com/abstract=832405 or http://dx.doi.org/10.2139/ssrn.832405

Maria Demertzis (Contact Author)

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

Nicola Viegi

University of Pretoria - Department of Economics ( email )

Pretoria 0002
South Africa

HOME PAGE: http://www.nviegi.net

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