The relationship between the variance of inflation and the variance of output under different types of monetary policy
Alejandro Rodríguez Arana ()
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Alejandro Rodríguez Arana: Department of Economics, Universidad Iberoamericana, Mexico City. Mexico
Working Papers from Universidad Iberoamericana, Department of Economics
When the central bank minimizes a quadratic loss function depending upon the inflation gap and the output gap, a negative association between the variance of inflation and the variance of output emerges. The variance of output will be higher the greater is the preference of the central bank for stabilizing inflation. The use of certain ad-hoc interest rate rules analyzed in the literature may break the described negative relation. Central banks could reduce both variances. Data mainly from the US suggests that central banks use adhoc interest rate rules more than the minimization of the quadratic loss function.
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