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The Nonlinear Phillips Curve and Inflation Forecast Targeting - Symmetric Versus Asymmetric Monetary Policy Rules

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  • Schaling, E.

Abstract

We study a simple, small dynamic economy that a policymaker is attempting to control via use of a monetary policy rule. The model features a convex Phillips curve, in that positive deviations of aggregate demand from potential are more inflationary than negative deviations are disinflationary. Using dynamic optimization techniques, we find that the form of the optimal monetary policy reaction function is asymmetric. We show that in the optimal rule the interest rate is a nonlinear function of the deviation of inflation from its target and of output from potential. With asymmetry, optimal monetary policy becomes more active as uncertainty about the impact of policy increases. We thus provide an important and novel theoretical reason why increased uncertainty can lead to more aggressive rather than toward more cautious optimal policies.
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Suggested Citation

  • Schaling, E., 1998. "The Nonlinear Phillips Curve and Inflation Forecast Targeting - Symmetric Versus Asymmetric Monetary Policy Rules," Discussion Paper 1998-136, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:d6b03994-a406-4ac5-9c4d-1fc15ca05f3e
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    References listed on IDEAS

    as
    1. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    2. Svensson, Lars E O, 1997. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts," American Economic Review, American Economic Association, vol. 87(1), pages 98-114, March.
    3. Bankim Chadha & Paul R. Masson & Guy Meredith, 2019. "Models of Inflation and the Costs of Disinflation," World Scientific Book Chapters, in: Macroeconomic Modelling and Monetary and Exchange Rate Regimes, chapter 3, pages 57-99, World Scientific Publishing Co. Pte. Ltd..
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    5. Douglas Laxton & Guy Meredith & David Rose, 1995. "Asymmetric Effects of Economic Activity on Inflation: Evidence and Policy Implications," IMF Staff Papers, Palgrave Macmillan, vol. 42(2), pages 344-374, June.
    6. Eijffinger, Sylvester C W & Hoeberichts, Marco & Schaling, Eric, 2000. "Why Money Talks and Wealth Whispers: Monetary Uncertainty and Mystique," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(2), pages 218-235, May.
    7. Laxton, Douglas & Rose, David & Tambakis, Demosthenes, 1999. "The U.S. Phillips curve: The case for asymmetry," Journal of Economic Dynamics and Control, Elsevier, vol. 23(9-10), pages 1459-1485, September.
    8. Mr. Peter B. Clark & Mr. Douglas Laxton & David Rose, 1995. "Capacity Constraints, Inflation and the Transmission Mechanism: Forward-Looking Versus Myopic Policy Rules," IMF Working Papers 1995/075, International Monetary Fund.
    9. Eric Schaling, 1995. "Institutions and Monetary Policy," Books, Edward Elgar Publishing, number 547.
    10. Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1.
    11. Charles Nolan & Eric Schaling, 1996. "Monetary Policy Uncertainty and Central Bank Accountability," Bank of England working papers 54, Bank of England.
    12. Guy Debelle & Douglas Laxton, 1997. "Is the Phillips Curve Really a Curve? Some Evidence for Canada, the United Kingdom, and the United States," IMF Staff Papers, Palgrave Macmillan, vol. 44(2), pages 249-282, June.
    13. Joseph Stiglitz, 1997. "Reflections on the Natural Rate Hypothesis," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 3-10, Winter.
    14. Romer, Christina D. & Romer, David H. (ed.), 1997. "Reducing Inflation," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226724843, June.
    15. Peter Clark & Douglas Laxton & David Rose, 1996. "Asymmetry in the U.S. Output-Inflation Nexus," IMF Staff Papers, Palgrave Macmillan, vol. 43(1), pages 216-251, March.
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    More about this item

    Keywords

    inflation targets; nonlinearities; asymmetries; stochastic control;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • 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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