{
  "title": "Inflation Targeting Under Imperfect Policy Credibility",
  "publication": "IMF Working Papers, April 1, 2009",
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  "summary": "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 cr",
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    {
      "heading": "Summary / Model modifications",
      "content": "- The paper presents a model for Inflation Targeting under imperfect policy credibility.\n- The conventional model is modified in three ways:\n  - an endogenous policy credibility process, by which monetary policy can gain or lose credibility over time;\n  - non-linearities in the inflation equation and in the credibility generating process;\n  - an explicit loss function.\n- The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets.\n- 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."
    },
    {
      "heading": "Key findings and takeaways",
      "content": "- Endogenous credibility: Policy credibility is modeled as a process that can evolve endogenously—monetary policy actions can increase or decrease credibility over time.\n- Non-linearities: Introducing non-linearities in the inflation equation and the credibility-generating process alters policy trade-offs relative to linear models.\n- Loss function: An explicit loss function is used to evaluate policy outcomes and trade-offs.\n- Rigid near-term targets: Setting a series of rigid near-term inflation targets is problematic according to the model’s implications.\n- Supply shocks and trade-offs:\n  - Appropriate response to unfavorable supply shocks: interest rate increase, some loss of output, and a period of increased inflation.\n  - Delayed response risk: a delayed policy response can lead to a prolonged period of stagflation."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Avoid rigid series of near-term inflation targets; allow flexibility to account for credibility dynamics and non-linear responses.\n- Respond promptly to unfavorable supply shocks with higher interest rates, accepting some short-term output loss and temporary higher inflation to prevent prolonged stagflation.\n- Incorporate credibility dynamics explicitly into policy frameworks and communications to manage expectations over time."
    },
    {
      "heading": "Scenarios and dynamics emphasized",
      "content": "- Immediate tightening in response to supply shocks:\n  - interest rate increase;\n  - some loss of output;\n  - a period of increased inflation.\n- Delayed tightening:\n  - risk of a prolonged period of stagflation.\n\n---\n\n Content in this bundle\n\n- Wp0994\n  - Wp0994 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Wp0994 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/inflation-targeting-under-imperfect-policy-credibility-22494"
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    "Published: April 1, 2009",
    "Series: IMF Working Papers",
    "The paper presents a model for Inflation Targeting under imperfect policy credibility.",
    "The conventional model is modified in three ways:",
    "The model highlights problems associated with the practice of setting a series of rigid near-term inflation targets.",
    "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.",
    "Endogenous credibility: Policy credibility is modeled as a process that can evolve endogenously—monetary policy actions can increase or decrease credibility over time.",
    "Non-linearities: Introducing non-linearities in the inflation equation and the credibility-generating process alters policy trade-offs relative to linear models.",
    "Loss function: An explicit loss function is used to evaluate policy outcomes and trade-offs.",
    "Rigid near-term targets: Setting a series of rigid near-term inflation targets is problematic according to the model’s implications.",
    "Supply shocks and trade-offs:",
    "Avoid rigid series of near-term inflation targets; allow flexibility to account for credibility dynamics and non-linear responses.",
    "Respond promptly to unfavorable supply shocks with higher interest rates, accepting some short-term output loss and temporary higher inflation to prevent prolonged stagflation.",
    "Incorporate credibility dynamics explicitly into policy frameworks and communications to manage expectations over time.",
    "Immediate tightening in response to supply shocks:",
    "Delayed tightening:",
    "**Wp0994**"
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