Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibility

IMF Working Papers, January 1, 2001

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Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibility

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Bibliographic details

• Authors: Peter Isard, Douglas Laxton, Ann-Charlotte Eliasson
• Published: January 1, 2001
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451842418.001

Summary

• Stochastic simulations are employed to compare performance of monetary policy rules in linear and nonlinear variants of a small macro model with NAIRU uncertainity under different assumptions about the way inflation expectations are formed.
• Cases in which policy credibility is ignored or treated as exogenous are distinguished from cases in which credibility and inflation expectations respond endogenuously.
• Policy credibility strengthens the case for forward-looking inflation forecast based rules relative to backward-looking Taylor rules.

Methodology and Model Features

• Approach: Stochastic simulations.
• Model: Small macro model with linear and nonlinear variants.
• Key uncertainty: NAIRU uncertainity.
• Expectations frameworks compared:
  • Cases with credibility ignored or treated as exogenous.
  • Cases with credibility and inflation expectations responding endogenously.
• Policy rules evaluated:
  • Forward-looking inflation forecast based (IFB) rules.
  • Backward-looking Taylor rules.

Principal Findings

• Endogenous policy credibility affects the relative performance of monetary policy rules.
• Strengthening policy credibility increases the relative attractiveness of forward-looking inflation forecast based rules over backward-looking Taylor rules.

Policy Implications and Recommendations

• Consideration of endogenous credibility is important when assessing monetary policy rules.
• Forward-looking inflation forecast based rules gain support when policy credibility is accounted for endogenously.

Content in this bundle

• Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibilty - WP/01/7
  • Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibilty - WP/01/7 (Markdown version)
  • Inflation Targeting with NAIRU Uncertainty and Endogenous Policy Credibilty - WP/01/7 (PDF)