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Out of reach? Convergence to an inflation target in the Central Bank of Iceland’s macroeconomic model

Out of reach? Convergence to an inflation target in the Central Bank of Iceland’s macroeconomic model


Title: Out of reach? Convergence to an inflation target in the Central Bank of Iceland’s macroeconomic model
Author: Baldursson, Friðrik Már
Hall, Axel
Date: 2008
Language: English
Scope: 83-106
University/Institute: Háskólinn í Reykjavík
Reykjavik University
School: Viðskiptadeild (HR)
School of Business (RU)
Series: Tímarit um viðskipti og efnahagsmál;6(2)
ISSN: 1670-4444
1670-4851 (e-ISSN)
DOI: 10.24122/tve.a.2008.6.2.9
Subject: Verðbólga; Seðlabankar; Þjóðhagsspár
URI: https://hdl.handle.net/20.500.11815/208

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Citation:

Friðrik Már Baldursson; Axel Hall. (2008). Out of reach? Convergence to an inflation target in the Central Bank of Iceland’s macroeconomic model. Tímarit um viðskipti og efnahagsmál, 6(2), 83-106. Doi:doi.org/10.24122/tve.a.2008.6.2.9

Abstract:

Inflation scenarios in forecasts of the Central Bank of Iceland (CBI) appear to converge to the inflation target (2.5%) in 8-9 quarters. We ask whether this is a coincidence or an inherent property of the CBI’s model, QMM. We formulate a sub-model, containing equations for inflation, inflation expectations, wages, exchange rate and the policy interest rate. We find that rapid convergence toward the inflation target is a property of the QMM when a Taylor-rule is included in the model. Underlying is an inflation expectations equation which assumes a high degree of credibility of the CBI. This equation, however, lacks empirical underpinnings. When we replace the QMM expectations equation with an estimated equation, a more realistic picture emerges where the Central Bank has to raise the policy rate considerably higher than in QMM scenarios and it takes much longer to reach the inflation target.

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Creative Commons Attribution 4.0 License.

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