Distribution forecast targeting in an open-economy, macroeconomic volatility and financial implications

Alessandro Flamini () and Costas Milas

Journal of Financial Stability, 2015, vol. 16, issue C, 89-105

Abstract: In an open-economy faced with parameter uncertainty, this paper uses distribution forecasts to investigate the impact of alternative inflation targeting policies on macroeconomic volatility and their potential implications on financial stability. Theoretically, Domestic Inflation Targeting (DIT) leads to less volatility than Consumer Price Index Inflation Targeting (CPIIT) for several macroeconomic variables and, in particular, for the interest rate. Empirically, a positive relationship between interest rate volatility and financial instability emerges for the US, UK and Sweden since the early 1990s. Bridging theory and empirical evidence, we conclude that the choice of the inflation targeting regime has an important impact on macroeconomic volatility and potential implications for financial stability.

Keywords: Macroeconomic volatility; Financial stability; Interest rate volatility; Multiplicative uncertainty; Markov jump-linear-quadratic systems; Optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:16:y:2015:i:c:p:89-105

DOI: 10.1016/j.jfs.2014.12.001

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