How Should Central Banks Respond to Non-neutral Inflation Expectations?

Imran Shah, Ian Corrick, Abdul Saboor

Research output: Contribution to journalArticle

Abstract

This paper investigates the net real inflation effect on output in ten countries, comprising both advanced and developing countries. An indicator is introduced to compute the net inflation effect on output (NIEO) based on the difference between two concepts of core inflation, where both are computed using the decomposition of VAR residuals. We find that for all countries, when inflation is increasing the NIEO is significantly positive and is negative during periods of decreasing inflation. Typically, countries which follow anti-inflationary policies if the NIEO is of small magnitude suffer relatively minimal damage in output, whereas if the same policies are undertaken when the NIEO is large the damaging effects on output could be much greater. This suggests that the NIEO could be a useful indicator of the likely effects of policy, especially for countries which have frequent episodes of high inflation, and in those countries which employ inflation-targeting policy, as the timing of monetary policy actions could be optimized to take account of this real effect of inflation.
Original languageEnglish
Article numbers1107
Pages (from-to)321-351
Number of pages31
JournalOpen Economies Review
Volume29
Issue number2
Early online date26 Feb 2018
DOIs
Publication statusPublished - 1 Apr 2018

Keywords

  • Economic growth
  • Inflation
  • Monetary policy
  • Recession
  • VAR analysis

ASJC Scopus subject areas

  • Economics and Econometrics

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