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Inflation Targeting and the Dynamics of the Transmission Mechanism

Author

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  • Dillén, Hans

    (Monetary Policy Department, Central Bank of Sweden)

Abstract

This paper derives closed-form expressions for optimal monetary policy rules when the central bank can influence inflation directly with a one-period lag as well as a two-period lagged effect via the output gap. It turns out that even a modest one-period inflation effect from monetary policy actions has substantial implications for monetary policy that also seem to be a step towards increased realism. For instance, in models where the central bank only can affect inflation with a two-period lag via the output gap, policy becomes more aggressive and the output gap exhibits a tendency to switch sign frequently. This unrealistic oscillating feature can be avoided by allowing the central bank to influence inflation with a one-period lag. The model also illustrates that the nature of empirical (or reduced-form) Phillips curves may reflect monetary policy and the observation that the Phillips curve in recent years has become flatter can in this model be explained by a more counter-cyclical monetary policy.

Suggested Citation

  • Dillén, Hans, 2002. "Inflation Targeting and the Dynamics of the Transmission Mechanism," Working Paper Series 141, Sveriges Riksbank (Central Bank of Sweden), revised 01 Jul 2004.
    • Handle: RePEc:hhs:rbnkwp:0141
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    File URL: http://www.riksbank.com/upload/WorkingPapers/WP_141Revised.pdf
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    References listed on IDEAS

    as
    1. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
    2. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    3. Marianne Nessén & Ulf Söderström, 2001. "Core Inflation and Monetary Policy," International Finance, Wiley Blackwell, vol. 4(3), pages 401-439.
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    5. Doyle, Matthew & Beaudry, Paul, 2000. "What Happened to the Phillips Curve in the 1990s in Canada," Staff General Research Papers Archive 10286, Iowa State University, Department of Economics.
    6. Lars E. O. Svensson, 1999. "Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(3), pages 337-361, September.
    7. repec:bla:intfin:v:4:y:2001:i:3:p:401-39 is not listed on IDEAS
    8. Nessen, Marianne, 2002. "Targeting inflation over the short, medium and long term," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 313-329, September.
    9. repec:bla:scandj:v:101:y:1999:i:3:p:337-61 is not listed on IDEAS
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    11. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Inflation targeting; optimal monetary policy; the transmission mechanism;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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