Of Nutters and Doves
32 Pages Posted: 26 Feb 2007
Date Written: November 2006
We argue that there are conditions such that any inflation targeting regime is preferable to full policy discretion, even if long-run inflation rates are identical across regimes. The key observation is that strict inflation targeting outperforms the discretionary policy response to sufficiently persistent shocks. Under full policy discretion, inflation expectations over the medium term respond to the shock and thereby amplify its impact on output. As a result, little output stabilization is achieved at the cost of large and persistent inflation fluctuations.
Keywords: Monetary policy, inflation targeting, rules versus discretion
JEL Classification: E52, E58
Suggested Citation: Suggested Citation