A BEJM Contributions article.

Abstract

We investigate the optimality of monetary policy targeting rules in a macroeconomic model based on explicit micro-foundations for intrinsic persistence in inflation and real output. For the corresponding social welfare loss function to be minimized by the central bank, inertia arises endogenously in both the inflation and output gap stabilization objectives. In this framework, inflation targeting closely approximates the optimal precommitment policy for empirically relevant parameter values. Alternative policy rules, such as nominal income growth targeting, "speed-limit" targeting, or price level targeting, do not perform as well. Previous research has demonstrated lower social welfare losses with these alternative targeting rules; such findings are shown to be primarily a consequence of assuming the central bank minimizes a simple social loss function that is not consistent with the micro-foundations of a model with intrinsic persistence.

Submitted: April 27, 2007 · Accepted: January 17, 2008 · Published: March 10, 2008

Recommended Citation

Hanson, Michael S. and Kapinos, Pavel S. (2008) "Endogenous Persistence and the Performance of Inertial Targeting Rules," The B.E. Journal of Macroeconomics: Vol. 8 : Iss. 1 (Contributions), Article 11.
Available at: http://www.bepress.com/bejm/vol8/iss1/art11