Inflation Targeting, Learning and Q Volatility in Small Open Economies

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. Our results show that the Central Bank can reduce the volatility of consumption and asset price inflation more effectively if it does so with state-contingent preferences than with a Taylor-rule with fixed coefficients. In the state-contingent setup the policy authority reacts to asset price movements only if such movements cross critical thresholds