Research Papers in Economics, Department of Economics, Stockholm University
Inflation Target Instability and Interest Rates
Abstract: The implementation of explicit quantitative inflation
targets elucidates the assessment of credibility of future monetary policy.
Here the explicit inflation target is time-varying and stochastic with
asymmetric information. It is shown that central bank independence promotes
lower inflation but not at the cost of increased output variability. Marked
political instability and instrument dependence are detrimental to
credibility, and impede monetary policy with unchanged long term nominal
interest rates. The marginal effect from less independence on interest rate
volatility is increasing in political instability. Strategic delegation of
an optimal inflation target with a monetary reform eliminates the inflation
bias. Empirical evidence substantiates the predictions when confronted with
cross-country OECD data.
Keywords: inflation target; credibility; political instability; independence; (follow links to similar papers)
JEL-Codes: E52; E58; (follow links to similar papers)
31 pages, June 2, 1998
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