Open-economy Distribution Forecast Targeting, Macroeconomic Volatility and Financial Implication

Alessandro Flamini () and Costas Milas
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Alessandro Flamini: Department of Economics and Management, University of Pavia

No 80, DEM Working Papers Series from University of Pavia, Department of Economics and Management

Abstract: In an open-economy faced with model uncertainty, this paper uses distribution forecasts to investigate the impact of alternative inflation targeting policies on macroeconomic volatility and their potential implications on financial stability. Theoretically, Domestic Inflation Targeting (DIT) leads to less volatility than Consumer Price index Inflation Targeting (CPIIT) for several macroeconomic variables and, in particular, for the interest rate. Empirically, a positive relationship between interest rate volatility and financial instability emerges for the US, UK and Sweden since the early 1990s. Bridging theory and empirical evidence, we conclude that the choice of the inflation targeting regime has an important impact on macroeconomic volatility and potential implications for financial stability.

Keywords: Macroeconomic volatility; fi?nancial stability; interest rate volatility; multiplicative uncertainty; Markov jump linear quadratic systems; open-economy; optimal montary policy; infl?ation index. (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2014-06
New Economics Papers: this item is included in nep-for, nep-mac and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:pav:demwpp:080

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