Survey_OW_2000

Abstract

Our framework of analysis is a simple macroeconomic model of inflation, output and interest rates with adaptive expectations. Such models have been widely used in the above literature on monetary policy and inflation targeting, but typically the main focus has been on linear versions with quadratic objectives. We parameterize this model using alternatively data for the U.S. and for the Euro area. We compute the dynamically optimal monetary policies using a dynamic programming algorithm that can accommodate non-linearities in the economic structure, non-quadratic preferences and uncertainty. Our analysis of inflation zone targeting also relates in some respects to the literature on exchange rate target zones. Similar to the investigation of the dynamic behavior of exchange rates when the central bank attempts to maintain the exchange rate within an explicit zone in that literature, our analysis provides information on the dynamic behavior of inflation with policy that has zone characteristics. However, there are important differences. First, unlike exchange rates the control of inflation is much less direct so strict control of inflation within a fixed zone, even if it were desired, would not be feasible. And second, our objective is to formally explore the rationale for adopting policies with zone characteristics while the emphasis in the case of exchange rate zones is to investigate the dynamics once a target zone is imposed on the economy.