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Inflation Targeting Under Imperfect Policy Credibility

Inflation Targeting Under Imperfect Policy Credibility by International Monetary Fund
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This paper presents a model for Inflation Targeting under imperfect policy credibility. It modifies the conventional model in three ways: an endogenous policy credibility process, by which monetary policy can gain or lose credibility over time; non-linearities in the inflation equation and in the credibility generating process; and an explicit loss function. The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets. Also, unfavorable supply shocks pose a difficult problem: an appropriate response involves an interest rate increase, some loss of output, and a period of increased inflation. A delayed response can result in a prolonged period of stagflation.
International Monetary Fund; April 2009
30 pages; ISBN 9781452772271
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Title: Inflation Targeting Under Imperfect Policy Credibility
Author: International Monetary Fund