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Learning About the Term Structure and Optimal Rules for Inflation Targeting

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  • Eijffinger, Sylvester C W
  • Schaling, Eric
  • Tesfaselassie, Mewael F.

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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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5896.

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Date of creation: Oct 2006
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Handle: RePEc:cpr:ceprdp:5896

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Keywords: learning; rational expectations; separation principle; term structure of interest rates;

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References

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  1. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  2. Rudebusch, Glenn D. & Svensson, Lars E. O., 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," Working Paper Series 92, Sveriges Riksbank (Central Bank of Sweden).
  3. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  4. Schaling, E., 1998. "The Nonlinear Phillips Curve and Inflation Forecast Targeting - Symmetric Versus Asymmetric Monetary Policy Rules," Discussion Paper 1998-136, Tilburg University, Center for Economic Research.
  5. Wieland, Volker, 2000. "Learning by doing and the value of optimal experimentation," Journal of Economic Dynamics and Control, Elsevier, vol. 24(4), pages 501-534, April.
  6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  7. 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.
  8. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
  9. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
  10. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  11. Eijffinger, Sylvester C W & Schaling, Eric & Verhagen, Willem, 2000. "The Term Structure of Interest Rates and Inflation Forecast Targeting," CEPR Discussion Papers 2375, C.E.P.R. Discussion Papers.
  12. 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.
  13. 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.
  14. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  15. 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.
  16. James Bullard & Eric Schaling, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Working Papers 11, Economic Research Southern Africa.
  17. James B. Bullard & Eric Schaling, 2001. "New economy-new policy rules," Review, Federal Reserve Bank of St. Louis, issue May, pages 57-66.
  18. Volker Wieland, 2006. "Monetary Policy and Uncertainty about the Natural Unemployment Rate: Brainard-Style Conservatism versus Experimental Activism," The B.E. Journal of Macroeconomics, De Gruyter, vol. 0(1), pages 1.
  19. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers 462, Queen Mary, University of London, School of Economics and Finance.
  20. Andrew T. Levin & Richhild Moessner, 2005. "Inflation persistence and monetary policy design - an overview," Working Paper Series 539, European Central Bank.
  21. 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.
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Citations

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Cited by:
  1. 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.
  2. Mewael F. Tesfaselassie & Eric Schaling, 2009. "Managing Disinflation under Uncertainty," Working Papers 145, Economic Research Southern Africa.
  3. Evans, George & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," SIRE Discussion Papers 2008-03, Scottish Institute for Research in Economics (SIRE).
  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. Noah Williams & Lars E.O. Svensson, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," 2007 Meeting Papers 446, Society for Economic Dynamics.
  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. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302 Elsevier.
  8. David A. Kendrick & Hans M. Amman & Marco P. Tucci, 2008. "Learning About Learning in Dynamic Economic Models," Working Papers 08-20, Utrecht School of Economics.

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