Transparency, expectations anchoring and inflation target

Abstract

In various speeches, former Fed Chairman Ben Bernanke contrasted the proposal of setting a higher inflation target by claiming that it could unanchor inflation expectations. A standard New Keynesian framework with learning supports this claim both asymptotically, because a higher inflation target shrinks the E-stability region when a central bank follows a Taylor rule, and in the transition phase, because a higher inflation target slows down the speed of convergence of expectations. Transparency helps anchoring expectations. However, the importance of being transparent diminishes with the level of the inflation target. Finally, the higher the inflation target, the more policy should respond to inflation and the less to output to guarantee E-stability. Hence, a policy that increases both the inflation target and the monetary policy response to output would be "reckless".

The Science of Monetary Policy: An Imperfect Knowledge Perspective

“…Less credible announcements, re ‡ected in greater weight on historical patterns of data when forecasting, generate larger and more variable sacri…ce ratios. Ascari, Florio, and Gobbi (2014), building on Eusepi (2005), show communication improves EStability in models where only one-period-ahead expectations matter, but where average in ‡ation rates are greater than zero. Finally, Honkapohja and Mitra (2014) provide a global analysis of the zero lower bound.…”

Trend inflation and monetary policy regimes in Japan

“…Thus, in this modeling framework we can consider µ t is the trend inflation under the current regime. If G(s t ) in (2) is equal to 0, µ t = µ (1) , while G(s t ) = 1 implies µ t = µ (2) . Thus, trend inflation modeled as (2) is assumed to have two regimes characterized by µ (1) and µ (2) , and trend inflation generally takes the value between them depending on the value of the transition function G.…”

“…In addition, we assume 0.05 < c < 0.95 so that we can detect the regime shifts in trend inflation within the sample period. In this setting, G(s t ) takes the value close to zero with smaller s t around the beginning of the sample period, making µ t close to µ (1) . Therefore, µ (1) can be considered to be the trend inflation around the beginning of the sample.…”

“…In this setting, G(s t ) takes the value close to zero with smaller s t around the beginning of the sample period, making µ t close to µ (1) . Therefore, µ (1) can be considered to be the trend inflation around the beginning of the sample. In contrast, around the end of the sample, µ t approaches µ (2) as G(s t ) approaches one with a larger s t .…”

“…In achieving this inflation target, one of the crucial indicators is trend inflation, which is defined as the infinite horizon forecast of inflation, that is, the level to which inflation is expected to settle after short-run fluctuations die out. 1 Since inflation is anticipated to approach the trend inflation in the future, aside from the short-term fluctuations along with the business cycles, the trend inflation can provide a useful measure with which to evaluate the appropriateness of the current monetary policy, as well as the necessity of additional monetary easing in order to achieve the inflation target. Therefore, it is extremely informative to examine the current trend inflation level and compare it with the inflation target set by the monetary authorities.…”