A Model for Full-Fledged Inflation Targeting and Application to Ghana
IMF Working Papers, January 1, 2010
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Bibliographic details
- Authors: Kevin Clinton, Jihad Dagher, Ondrej Kamenik, Douglas Laxton, Ali Alichi, Marshall Mills
- Published: January 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451962444.001
Summary findings
- A model in which monetary policy pursues full-fledged inflation targeting adapts well to Ghana.
- Model features include:
- endogenous policy credibility;
- non-linearities in the inflation process;
- a policy loss function that aims to minimize the variability of output and the interest rate, as well as deviations of inflation from the long-term low-inflation target.
- The optimal approach from initial high inflation to the ultimate target is gradual; and transitional inflation-reduction objectives are flexible.
- Over time, as policy earns credibility:
- expectations of inflation converge towards the long-run target;
- the output-inflation variability tradeoff improves;
- optimal policy responses to shocks moderate.
Policy implications and recommendations
- Adopt full-fledged inflation targeting with attention to building endogenous policy credibility.
- Account for non-linearities in the inflation process when designing policy rules.
- Use a policy loss function that balances:
- variability of output;
- variability of the interest rate;
- deviations of inflation from the long-term low-inflation target.
- Follow a gradual strategy from high initial inflation toward the long-run target, allowing flexibility in transitional inflation-reduction objectives.
- As credibility is established, reduce the aggressiveness of policy responses to shocks in line with improved output-inflation tradeoffs.
Application to Ghana
- The model framework is presented as well-suited for Ghana given the features listed above (endogenous credibility, non-linear inflation dynamics, and a multi-objective loss function).
- Emphasis on gradual transition paths and flexible interim targets is highlighted as optimal in the Ghanaian context.
- Expected dynamics under successful implementation:
- convergence of inflation expectations to the long-run target;
- improved tradeoffs between output variability and inflation variability;
- moderated optimal policy responses to shocks.