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Efficient Inflation Targets for Distorted Dynamic Economies*

By Costas Azariadis and Raphael W. K. Lam

Abstract

Economics at UCLA is gratefully acknowledged. What are good inflation targets and by what instrument rules can they be reached? We examine the selection of targets and instruments, in competitive exchange economies with lifecycle consumers facing uninsurable idiosyncratic income risks, by a benevolent monetary authority that seeks to eliminate indeterminacy, thicken asset markets, and influence the choices of an impatient fiscal authority. A low inflation target, together with a backward-looking Taylor rule are sufficient to defeat the indeterminacy that prevails in Sargent and Wallace’s ‘unpleasant monetarist arithmetic ’ model. However, strategic interaction with the fiscal authority, and the desire to provide social insurance against privately uninsurable income risks, will raise the inflation target beyond what is ideal in undistorted economies and above what is desired by either the monetary or the fiscal authority. 2 1. THE TASKS OF MONETARY POLICY Most central banks in OECD countries intervene in credit markets to achieve a targe

Year: 2003
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