Inflation zone targeting

We study optimal monetary policy design in a simple model that deviates fro m the linear-quadratic paradigm and provides a rationale for the practice o f inflation zone targeting. We show that the presence of either zone-quadra tic preferences or a zone-linear relationship between inflation and economi c activity provides strong incentives to deviate from conventional linear p olicies. We calibrate the model based on parameters for the United States a nd the euro area and employ a numerical dynamic programming algorithm to de rive the optimal policies. With this algorithm, we examine the role of unce rtainty, model structure and relative preference towards economic stability in determining the width of the implied targeted inflation zone. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: E31; E52; E5 8; E61.