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The Role of Inflation Target Adjustment in Stabilization Policy

Yunjong Eo () and Denny Lie ()

No 2017-06, Working Papers from University of Sydney, School of Economics

Abstract: How and under what circumstances can adjusting the inflation target serve as a stabilization-policy tool and contribute to welfare improvement? We answer these questions quantitatively with a standard New Keynesian model that includes cost-push type shocks. Our proposed inflation target rule calls for the target to be adjusted in a persistent manner and in the opposite direction to the realization of a cost-push shock, which is essentially a makeup strategy. The inflation target rule, combined with a Taylor-type rule, significantly reduces inflation fluctuations originating from cost-push shocks and mitigates the stabilization trade-off, resulting in a similar level of welfare to that associated with the Ramsey optimal policy.

Keywords: Cost-push shocks; Inflation-output trade-off; Makeup strategy; Medium-run inflation targeting; Welfare analysis; Monetary policy; Nominal wage rigidity; Capital accumulation; Flat Phillips curve (search for similar items in EconPapers)
Date: 2017-05, Revised 2019-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Related works:
Journal Article: The Role of Inflation Target Adjustment in Stabilization Policy (2020) Downloads
Working Paper: The role of inflation target adjustment in stabilization policy (2017) Downloads
Working Paper: The Role of Inflation Target Adjustment in Stabilization Policy (2017) Downloads
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