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Has inflation targeting improved social welfare in practice?

By Eiji Okano

Abstract

This article verifies empirically the proposition that inflation targeting can improve social welfare. To analyse this, we construct a cashless small open-economy model conforming to the New Keynesian Open-Economy Macroeconomics and use data in the United Kingdom. We estimate the feedback rule, before estimating the deep parameters using GMM. Using the estimated structural model and identified shock processes, we simulate the imaginary paths of the nominal interest rate, producer price index inflation rate and output if the central bank has not adopted an inflation targeting policy. This simulation shows that the variances of output and the inflation rate under a noninflation targeting regime are larger than those under the actual inflation targeting regime. We also calculate social loss, as defined by the second-order approximated utility function under each regime. The results indicate that social loss brought about by an inflation targeting regime is less than that associated with a noninflation targeting regime.

DOI identifier: 10.1080/13504850600706644
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