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Discussion of Designing Inflation Targets

Discussion of Designing Inflation Targets - Discussion 1...

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Discussion 1. Don Brash The range of issues relevant to the design of an inflation-targeting framework means that a fully comprehensive review is a very substantial task. Haldane has wisely narrowed down his field of discussion to three questions: what level to set an inflation target?; over what horizon?; and should inflation forecasts be published? Haldane makes a very welcome contribution to all of these topics. The paper covers a sufficiently wide scope of empirical and practical issues to preclude a detailed discussion of them all in the space available. The comments below therefore focus on the twin themes of goals versus operational policy and the role of transparency. In terms of the latter, I comment on some practical issues associated with the Reserve Bank of New Zealand’s recent moves to increase the transparency of its operations. Finally, some brief comments are offered on the literature on the costs of inflation and disinflation. Goals, operational independence and transparency Haldane’s organising framework is based on how to specify the monetary authority’s policy reaction function (his Equation (1)). While useful in many respects, this approach does not itself distinguish clearly between goals and operational policy. The implicit assumption made is that it is feasible and desirable for the legislative framework for monetary policy to specify the parameters of the policy reaction function. This approach therefore does not explicitly consider issues of incentives, pre-commitment, and verifiability and accountability. An alternative view is that the design of an inflation-targeting framework would ideally take place in two steps. The first step would be to determine the most appropriate (socially optimal) policy reaction function based on the structure of the economy and the known frequencies (joint probability distribution) of demand and supply disturbances. The second step would be to design an inflation-targeting framework that induces the central bank to implement the desired outcome. However, a critical problem with this alternative approach is that it assumes the designers have much more knowledge about the economy than is the case. In particular, the approach requires an extremely good knowledge of the structure of the economy and how it may change over time due to the new monetary regime or other factors. Our lack of knowledge about these matters means that inflation-targeting frameworks have in practice been designed with specific focus on the goals of policy, rather than on operational policy. Central banks have been given operational independence so that the policy reaction function may be altered as we learn more about the economy and how it is changing over time.
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