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Performance of Inflation Targeting Based on Constant Interest Rate Projections

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  • Honkapohja, Seppo
  • Mitra, Kaushik

Abstract

Monetary policy is sometimes formulated in terms of a target level of inflation, a fixed time horizon and a constant interest rate that is anticipated to achieve the target at the specified horizon. These requirements lead to constant interest rate (CIR) instrument rules. Using the standard New Keynesian model, it is shown that some forms of CIR policy lead to both indeterminacy of equilibria and instability under adaptive learning. Some other forms of CIR policy perform better, however. We also examine the properties of the different policy rules in the presence of inertial demand and price behaviour.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4126.

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Date of creation: Dec 2003
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Handle: RePEc:cpr:ceprdp:4126

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Keywords: indeterminacy; inertia in demand; inflation inertia; inflation targeting; instability under learning;

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References

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  1. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  2. Kaushik Mitra & James Bullard, 2004. "Determinacy, Learnability, and Monetary Policy Inertia," Royal Holloway, University of London: Discussion Papers in Economics 04/14, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  3. Honkapohja, S. & Mitra, K., 2001. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," University of Helsinki, Department of Economics 501, Department of Economics.
  4. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
  5. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 807-824.
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  18. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
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Citations

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Cited by:
  1. Arnab Bhattacharjee & Sean Holly, 2004. "Inflation Targeting, committee Decision Making and Uncertainty: The case of the Bank of England's MPC," Money Macro and Finance (MMF) Research Group Conference 2004 63, Money Macro and Finance Research Group.
  2. George W. Evans & Seppo Honkapohja, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," CDMA Working Paper Series 200802, Centre for Dynamic Macroeconomic Analysis.
  3. Michael Woodford, 2007. "Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice," NBER Working Papers 13716, National Bureau of Economic Research, Inc.
  4. Jordi Gali, 2008. "Are Central Banks' Projections Meaningful?," 2008 Meeting Papers 174, Society for Economic Dynamics.
  5. Alessandro Flamini, 2012. "Interest Rate Forecasts in Inflation Targeting Open-Economies," DEM Working Papers Series 027, University of Pavia, Department of Economics and Management.
  6. Andreas Schabert & Markus Hörmann, 2009. "An Interest Rate Peg Might Be Better than You Think," Ruhr Economic Papers 0115, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  7. Berg, Claes & Jansson, Per & Vredin, Anders, 2004. "How Useful are Simple Rules for Monetary Policy? The Swedish Experience," Working Paper Series 169, Sveriges Riksbank (Central Bank of Sweden).
  8. Galí, Jordi, 2010. "Are Central Banks' Projections Meaningful?," CEPR Discussion Papers 8027, C.E.P.R. Discussion Papers.
  9. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Are Constant Interest Rate Forecasts Modest Interventions? Evidence from an Estimated Open Economy DSGE Model of the Euro Area," Working Paper Series 180, Sveriges Riksbank (Central Bank of Sweden).
  10. Thoma, Mark, 2008. "Structural change and lag length in VAR models," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 965-976, September.
  11. Galí, Jordi, 2011. "Are central banks' projections meaningful?," Journal of Monetary Economics, Elsevier, vol. 58(6), pages 537-550.

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