DP4229 Implementing Optimal Policy Through Inflation-Forecast Targeting

Author(s): Lars E O Svensson , Michael Woodford

Publication Date: February 2004

Keyword(s): inflation targeting , commitment , discretion

JEL(s): E42 , E52 , E58

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4229.asp

We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.