SSE/EFI Working Paper Series in Economics and Finance
Inflation Rules with Consistent Escape Clauses
Abstract: Simple inflation targets may be supplemented with an
escape clause to be evoked in case the economy is hit by a major supply
shock. In this paper, consistent solutions to the Flood and Isard (1990)
escape clause model are derived in the spirit of Lohmann (1990), She showed
that Flood and Isard's assumption of symmetric boundary values of shocks,
outside of which the zero inflation rule should be broken, is inconsistent
if the output or employment target differs from the natural rate. This is
quantitatively important since the optimal boundary values in the
consistent model are highly asymmetric. The effects of unemployment
persistence on the optimal escape clause are also investigated in a two
period version of the model. In the second period, monetary policy should
respond more often to supply shocks if unemployment is persistent. The
first period effect may be of either sign.
Keywords: Escape clauses; monetary policy; (follow links to similar papers)
JEL-Codes: E52; (follow links to similar papers)
35 pages, January 1996
- This paper is forthcoming as:
Alexius, Annika, 'Inflation Rules with Consistent Escape Clauses', European Economic Review.
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