Inflation targeting, learning and Q volatility in small open economies

Abstract

This paper examines the welfare implications of managing asset-price with consumer-price inflation targeting by monetary authorities who have to learn the laws of motion for both inflation rates. The central bank can reduce the volatility of consumption as well as improve welfare more effectively if it adopts state-contingent Taylor rules aimed at inflation and Q-growth targets in this learning environment. However, under perfect model certainty, pure inflation targeting dominates combined consumer and asset-price inflation targeting. © 2007 Elsevier B.V. All rights reserved.