Inflation Targeting and Monetary Policy Activism

Abstract

IMES Discussion Paper Series 2008-E-13 July 2008 Inflation Targeting and Monetary Policy ActivismToshitaka Sekine* and Yuki Teranishi** Abstract We estimate monetary policy activism, defined as responsiveness of the policy interest rate to inflation, among five inflation-targeting countries (the UK, Canada, Sweden, Australia and New Zealand) plus the G3 (the US, Japan and Germany) by applying a time-varying parameter with a stochastic-volatility model. We find that activism of inflation-targeting countries tends to have increased before (not after) the adoption of the inflation-targeting policy framework and that these countries have experienced a decline in activism in recent years, albeit to different degrees.We further explore this result in terms of the constraint of an inflation target range by developing a formal theoretical model in a New Keynesian framework. This research has benefited from comments and discussions with Keywords

How Does Monetary Policy Change? Evidence on Inflation-Targeting Countries

“…Inflation had already been contained in the 1980s and the very benign inflation environment was also supported by declining prices of raw materials on world markets. This corroborates the findings of Kuttner and Posen (1999) and Sekine and Teranishi (2008), who show that IT can be associated with less aggressive monetary policy.…”

“…Contrary to common perceptions, the response can become less aggressive after the adoption of IT, suggesting a positive anchoring effect of this regime on inflation expectations or a low-inflation environment. This result is consistent with those of Kuttner and Posen (1999) and Sekine and Teranishi (2008), who show that IT can be associated with a smaller response of the interest rate to inflation developments if the previous inflation record was favorable.…”

“…Credible monetary policy does not have to react so strongly to inflation surprises, as inflation expectations are likely to remain anchored [Libich (2009)]. Sekine and Teranishi (2008) provide a new Keynesian model that reaches the same conclusions. Siklos and Weymark (2009) estimate that IT in Australia, Canada, and New Zealand reduced the magnitude of the interest-rate changes to needed to maintain a low-inflation environment.…”

“…21 In all cases, we confirm that the framework does not imply oversmoothing and is able to reproduce abrupt switches. Nevertheless, the ability of the time-varying parameter models to identify sudden structural breaks in parameters remains to be confirmed by careful Monte Carlo simulations, as pointed out by Sekine and Teranishi (2008).…”

Another look at global disinflation

“…For Sweden, the series prior to 1982Q1 is obtained from the national source through the BIS Data Bank. 8 Sekine and Teranishi (2008) find that most of central banks investigated in this paper have increased the responsiveness of their policy interest rates to inflation.…”