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Permanent and Transitory Policy Shocks in an Empirical Macro Model with Asymmetric Information

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Author Info
Sharon Kozicki () (Federal Reserve Bank of Kansas City)
P.A. Tinsley () (Faculty of Economics and Politics, University of Cambridge)

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Abstract

Despite a large literature documenting that the efficacy of monetary policy depends on how inflation expectations are anchored, many monetary policy models assume: (1) the inflation target of monetary policy is constant; and, (2) the inflation target is known by all economic agents. This paper proposes an empirical specification with two policy shocks: permanent changes to the inflation target and transitory perturbations of the short-term real rate. The public sector cannot correctly distinguish between these two shocks and, under incomplete learning, private perceptions of the inflation target will not equal the true target. The paper shows how imperfect policy credibility can affect economic responses to structural shocks, including transition to a new inflation target – a question that cannot be addressed by many commonly used empirical and theoretical models. In contrast to models where all monetary policy actions are transient, the proposed specification implies that sizable movements in historical bond yields and inflation are attributable to perceptions of permanent shocks in target inflation.

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Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2003/41.

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Length: 49 pages
Date of creation: 10 Feb 2003
Date of revision:
Handle: RePEc:cfs:cfswop:wp200341

Note: An earlier version was presented at the 2003 conference on "Expectations, Learning, and Monetary Policy" sponsored by the Center for Financial Studies, the Deutsche Bundesbank, and the Journal of Economic Dynamics and Control in Eltville, Germany, the 1999 American Economic Association annual meetings, the 1999 Conference on Computing in Economics and Finance of the Society of Computational Economics, the Federal Reserve Board, and the Federal Reserve Bank of Kansas City. We received many constructive comments from Michael Binder, William Branch, Alex Cukierman, and Reinhard Tietz for which we are very grateful. Thanks also to Matthew Cardillo for excellent research assistance. The views expressed are those of the authors and do not necessarily represent those of the Federal Reserve Bank of Kansas City or the Federal Reserve Board.
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Related research
Keywords: transmission mechanism; learning; policy credibility; time-varying natural rate; shifting endpoint; inflation target; term structure of interest rates;

Other versions of this item:

Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information

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References listed on IDEAS
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