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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. Glenn D. Rudebusch & Lars E.O. Svensson, 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," NBER Working Papers 7179, National Bureau of Economic Research, Inc.
  2. 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.
  3. 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.
  4. 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.
  5. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  6. Yetman, James, 2000. "Probing Potential Output: Monetary Policy, Credibility, and Optimal Learning under Uncertainty," Working Papers 00-10, Bank of Canada.
  7. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  8. Lars E. O. Svensson, 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  9. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  10. Eric Schaling & James Bullard, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Computing in Economics and Finance 2005 362, Society for Computational Economics.
  11. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers 462, Queen Mary, University of London, School of Economics and Finance.
  12. 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.
  13. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  14. 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.
  15. Bullard, J. & Schaling, E., 2000. "New Economy - New Policy Rules?," Discussion Paper 2000-72, Tilburg University, Center for Economic Research.
  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. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
  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. 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. Mewael F. Tesfaselassie & Eric Schaling, 2009. "Managing Disinflation under Uncertainty," Working Papers 145, Economic Research Southern Africa.
  2. Lars E.O. Svensson & Noah Williams, 2009. "Optimal Monetary Policy under Uncertainty in DSGE Models: A Markov Jump-Linear-Quadratic Approach," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 3, pages 077-114 Central Bank of Chile.
  3. Williams, Noah, 2012. "Monetary policy under financial uncertainty," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 449-465.
  4. Noah Williams & Lars E.O. Svensson, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," 2007 Meeting Papers 446, Society for Economic Dynamics.
  5. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.
  6. 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.
  7. 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.
  8. 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.

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