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Learning about the Term Structure and Optimal Rules for Inflation Targeting

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  • MEWAEL F. TESFASELASSIE
  • ERIC SCHALING
  • SYLVESTER EIJFFINGER

Abstract

In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. We find that under flexible inflation targeting and uncertainty in the degree of persistence in the economy, allowing for active learning possibilities has effects on the optimal interest rate rule followed by the central bank. For a wide range of possible initial beliefs about the unknown parameter, the dynamically optimal rule is in general more activist, in the sense of responding aggressively to the state of the economy, than the myopic rule for small to moderate deviations of the state variable from its target. On the other hand, for large deviations, the optimal policy is less activist than the myopic and the certainty equivalence policies.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2011.00463.x
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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 43 (2011)
Issue (Month): 8 (December)
Pages: 1685-1706

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Handle: RePEc:mcb:jmoncb:v:43:y:2011:i:8:p:1685-1706

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References

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  1. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  2. Ellison, Martin & Valla, Natacha, 2000. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Working Paper Series 0028, European Central Bank.
  3. James Yetman, 2000. "Probing Potential Output: Monetary Policy, Credibility And Optimal Learning Under Uncertainty," Computing in Economics and Finance 2000 181, Society for Computational Economics.
  4. James B. Bullard & Eric Schaling, 2001. "New economy-new policy rules," Review, Federal Reserve Bank of St. Louis, issue May, pages 57-66.
  5. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  6. Pollock, D. S. G., 2003. "Recursive estimation in econometrics," Computational Statistics & Data Analysis, Elsevier, vol. 44(1-2), pages 37-75, October.
  7. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  8. Bullard, James & Schaling, Eric, 2006. "Monetary policy, determinacy, and learnability in the open economy," Working Paper Series 0611, European Central Bank.
  9. Rudebusch, Glenn D. & Svensson, Lars E. O., 2002. "Eurosystem monetary targeting: Lessons from U.S. data," European Economic Review, Elsevier, vol. 46(3), pages 417-442, March.
  10. Kiefer, Nicholas M & Nyarko, Yaw, 1989. "Optimal Control of an Unknown Linear Process with Learning," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 571-86, August.
  11. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  12. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1998. "The Term Structure of Interest Rates and Inflation Forecast Targeting," Discussion Paper 1998-85, Tilburg University, Center for Economic Research.
  13. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  14. Klok, H.J. & Schaik, A.B.T.M. van & Smulders, J.A., 2001. "Economologues: Liber Amicorum voor Theo van de Klundert," Open Access publications from Tilburg University urn:nbn:nl:ui:12-86472, Tilburg University.
  15. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  16. Tesfaselassie, M.F., 2005. "Communication, Learning and Optimal Monetary Policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-173210, Tilburg University.
  17. Schaling, Eric, 2004. "The Nonlinear Phillips Curve and Inflation Forecast Targeting: Symmetric versus Asymmetric Monetary Policy Rules," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 361-86, June.
  18. James B. Bullard, 1991. "Learning, rational expectations and policy: a summary of recent research," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 50-60.
  19. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers 462, Queen Mary, University of London, School of Economics and Finance.
  20. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
  21. Schaling , Eric & Eijffinger , Sylvester & Tesfaselassie , Mewael, 2004. "Heterogeneous information about the term structure, least-squares learning and optimal rules for inflation targeting," Research Discussion Papers 23/2004, Bank of Finland.
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Citations

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Cited by:
  1. D.A. Kendrick & H.M. Amman & M.P. Tucci, 2008. "Learning About Learning in Dynamic Economic Models," Working Papers 08-20, Utrecht School of Economics.
  2. Tesfaselassie, M.F. & Schaling, E., 2010. "Managing disinflation under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 34(12), pages 2568-2577, December.
  3. Lars E.O. Svensson & Noah Williams, 2008. "Optimal Monetary Policy under Uncertainty in DSGE Models: A Markov Jump-Linear-Quadratic Approach," NBER Working Papers 13892, National Bureau of Economic Research, Inc.
  4. Lars E.O. Svensson & Noah Williams, 2008. "Optimal Monetary Policy Under Uncertainty in DSGE Models: A Markov Jump-Linear-Quadratic Approach," Working Papers Central Bank of Chile 484, Central Bank of Chile.
  5. Lars E.O. Svensson & Noah M. Williams, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," NBER Working Papers 13414, National Bureau of Economic Research, Inc.
  6. Eric Schaling & Marco Hoeberichts, 2010. "Why Speed Doesn’t Kill: Learning to Believe in Disinflation," De Economist, Springer, vol. 158(1), pages 23-42, April.
  7. Williams, Noah, 2012. "Monetary policy under financial uncertainty," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 449-465.
  8. Lars E.O. Svensson & Noah Williams, 2008. "Optimal monetary policy under uncertainty: a Markov jump-linear-quadratic approach," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 275-294.
  9. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.

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