The eventual failure and price indeterminacy of inflation targeting

Source: RePEc


In stark contrast to the previous literature, we find that IT leads to price indeterminacy even when the central bank uses a Taylor-like feedback rule to peg the nominal interest rate. We also find that there is no mechanism with IT to determine the current inflation rate or price level. We conclude that the previous literature has either committed mathematical errors involving infinity or misused the non-explosive criterion for ruling out speculative bubbles. To avoid making errors involving infinity, we analyze inflation targeting (IT) in a typical rational-expectations, pure-exchange, general-equilibrium model where the time horizon is arbitrarily large, but finite.

Download full-text


Available from: David Eagle
  • Source
    • "As one can see in the discussions by Sims (1994) (2003) and Woodford (1995, 2003), the same problems arise. Eagle (2006, 2007) also criticizes the selection of only locally-bounded nominal solutions, with a larger literature review. He emphasizes the counterintuitive signs of off-equilibrium responses. "
    [Show abstract] [Hide abstract]
    ABSTRACT: The new-Keynesian, Taylor-rule theory of inflation determination relies on explosive dynamics. By raising interest rates in response to inflation, the Fed does not directly stabilize future inflation. Rather, the Fed threatens hyperinflation, unless inflation jumps to one particular value on each date. However, there is nothing in economics to rule out hyperinflationary or deflationary solutions. Therefore, inflation is just as indeterminate under "active" interest rate targets as it is under standard fixed interest rate targets. Inflation determination requires ingredients beyond an interest-rate policy that follows the Taylor principle.
    Preview · Article · Oct 2007 · SSRN Electronic Journal