Do we really know how inflation targeters set interest rates?

Marcela Meirelles Aurelio

No RWP 05-02, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In inflation targeting (IT) regimes, the Monetary Authority announces an explicit objective, the target for inflation. However, other objectives that possibly conflict with the inflation goal are present, such as keeping output close to its potential level and the stability of financial markets. This multiplicity of objectives has spurred a debate on whether inflation targeting really provides a transparent framework for monetary policy. This question is addressed in this paper, focusing on the experience of six countries that adopted IT. The empirical investigation is based on a variety of data sets (including real time data and Central Bank's forecasts), as well as on alternative forward-looking reaction functions. The main finding is that, if transparency is interpreted as the short run predictability of policy actions, consistent with the announced inflation goal, then most of the IT regimes here examined are remarkably transparent. However, this is not necessarily true if a more broad interpretation of transparency is required. The data also reveals a certain degree of heterogeneity across countries and time, and therefore recommends caution with respect to general statements regarding the properties of IT regimes.

Keywords: Interest rates; Inflation (Finance); Monetary policy; Forecasting (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-cba, nep-cwa, nep-fmk, nep-mac, nep-mon and nep-sea
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Citations: View citations in EconPapers (5)

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