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Prepared by Silvia Sgherri.
Over the 1990’s, New Zealand, Canada, the United Kingdom, Sweden, and Australia all changed the institutional framework under which monetary policy was conducted, by shifting to an inflation targeting regime. Norway and Iceland followed suit in 2001. The literature on the institutional aspects of inflation targeting in industrial countries is vast. For a recent review, see Bernanke and Woodford (2005) and references therein.
On recently introduced measures enhancing the transparency of Norway’s monetary framework and related discussion, see the staff report.
Christiano and Gust (2000) emphasize that a high inflation expectations trap may arise if policy accommodates inflation.
Sack and Wieland (2000) provide an in depth discussion of interest rate smoothing. On the issue of gradualism as optimal response to uncertainty, see Brainard (1967) as canonical reference on the theory side, Woodford (1999) for a recent application, and Walsh (2003) for an exhaustive review.
In the case of Norway, all pairwise correlations between the three output gap measures are statistically significant, ranging between 0.24 (between yHP and yARMC) and 0.58 (between yHP and yDGAP. For all countries, the adjusted real unit labor cost exhibits the least synchronized behavior.
For the United Kingdom, this holds true in five out of six specifications, while the estimate of λ becomes significant when the output gap is proxied by the HP filter and price changes are measured by core inflation. The same exception remains valid in Table II-2, when deviations from PPP are also allowed for.
The debate on the significance of monetary responses to changes in asset prices remains open. While some authors claim that including asset prices in the central bank’s policy rule may be optimal (Cecchetti and others, 2000; Bordo and Jeanne, 2002) and that central banks react significantly to stock market movements by changing the short-term interest rate (Rigobon and Sack, 2003), other studies argue that central banks should not respond directly to asset prices (Bernanke and Gertler, 2001). Allowing for nonlinearity in the monetary reaction function could help to shed some light on this empirical issue.