Central Bank Preferences, Distribution Forecasts and Economic Stability in a Small Open-economy

Alessandro Flamini ()

No 2009005, Working Papers from The University of Sheffield, Department of Economics

Abstract: This paper relates the central bank's preferences on the inflation index and on the degree of smoothness of the interest rate to the quality of its forecasts and the expected perturbing impact of several shocks. The framework is a Markov jump-linear-quadratic system for optimal policy with model uncertainty in a timeless perspective. Comparing CPI and domestic inflation targeting, the latter implies considerably less variability in the distribution forecast of the economic dynamics. Furthermore, domestic inflation targeting stands out for much less sensitiveness to interest rate smoothing, and for resulting in more expected economic stability. Importantly, domestic inflation targeting allows significantly improving the prediction accuracy of the interest rate behaviour.

Keywords: Inflation targeting; additive and multiplicative uncertainty; Markov jump linear quadratic systems; small open-economy; optimal monetary policy; central bank preferences (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2009-03, Revised 2009-03
New Economics Papers: this item is included in nep-cba, nep-for, nep-mac and nep-mon
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