7 - Coordinating Inflation Forecasts
Published online by Cambridge University Press: 10 August 2009
Summary
In Part II, our focus was on developing a small-scale macroeconomic model that captured policy effects. We focused particular attention on how a policy emphasis on stabilizing inflation (adherence to the Taylor principle) could, under certain conditions, attain IOCS. The macroeconomic results presume coordination dynamics of a particular kind between policymakers and the public. These coordination dynamics between policymakers and the public center on the stream of information transmitted by price and on how policymakers could reduce the public's uncertainty about future inflation.
The threat posed by inflation is the noise it brings to bear on the price signals that the public uses when making forecasts and plans (see Friedman 1963, 1977). We know the noise exists, because there is a (positive) theoretical and empirical relation between inflation variability and the mean of inflation (see Vining and Elwertowski 1976; Parks 1978; Cukierman and Wachtel 1979; Taylor 1981). As we have argued, a policymaker's role is to assist in coordinating the public's information by reducing the noise in price signals. We now turn our attention to how aggressive inflation-stabilizing policy (adherence to the Taylor principle) coordinates accurate inflation forecasts.
Policymakers coordinate price information for the public in the following way. When policymakers achieve and maintain inflation stability, the public can substitute what it thinks is an implicit or explicit inflation target (set by the policymaker) for past inflation. In this environment, plans (i.e., contracts) now exhibit (price) stability.
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- The Role of Policymakers in Business Cycle Fluctuations , pp. 177 - 217Publisher: Cambridge University PressPrint publication year: 2006