An Evaluation of Monetary Targeting Regimes

Abstract

The policy regime in Europe has put the economy on 'auto-pilot'. We investigate different designs for the required feedback mechanisms. The uncertainty facing an economy depends on the pattern of shocks it faces, the response of the private sector to those shocks and also the policy reactions of the authorities. Two 'ideal type' policy regimes are investi gated, and inflation targeting is compared to nominal aggregate targeting. In general it is suggested that targeting a nominal aggregate reduces the variability of the price level, and stabilises the price level more quickly over time. Inflation outcomes are also less variable for the Euro Area, and they are less asymmetric when a nominal aggregate is targeted. The new European fiscal framework requires that countries set deficit targets close to balance. We show that there is plenty of space for automatic stabilisers to work, but the room available depends in part on the monetary policy framework chosen.