DP3365 The Inflation Forecast and the Loss Function
|Author(s):||Lars E.O. Svensson|
|Publication Date:||May 2002|
|Keyword(s):||inflation targeting, interest rate paths|
|JEL(s):||E42, E52, E58|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=3365|
This Paper argues that inflation-targeting central banks should announce explicit loss function with numerical relative weights on output-gap stabilization and use and announce optimal time-varying instrument-rate paths and corresponding inflation and output-gap forecasts. Simple voting procedures for forming the Monetary Policy Committee?s aggregate loss function and time-varying instrument-rate paths are suggested. Announcing an explicit loss function improves the transparency of inflation targeting and eliminates some misunderstandings of the meaning of ?flexible? inflation targeting. Using time-varying instrument-rate paths avoids a number of inconsistencies and other problems inherently associated with constant-interest-rate forecasts.