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Evaluating Inflation Targeting Using a Macroeconometric Model

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Abstract

This paper uses a structurally estimated macroeconometric model, denoted the MC model, to evaluate inflation targeting in the United States. Various interest rate rules are tried with differing weights on inflation and output, and various optimal control problems are solved using differing weights on inflation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to inflation targeting, especially for price shocks, 2) price-level targeting is dominated by inflation targeting, 3) the estimated interest rate rule of the Fed (in Table 4) is consistent with the Fed placing equal weights on inflation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1570.

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Length: 51 pages
Date of creation: Jun 2006
Date of revision: Mar 2007
Publication status: Published in The Open-Access, Open-Assessment E-Journal (2007-8)
Handle: RePEc:cwl:cwldpp:1570

Note: CFP 1570.
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Keywords: Inflation targeting; Interest rate rules; Optimal control;

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Cited by:
  1. Fair, Ray C., 2008. "Testing price equations," European Economic Review, Elsevier, vol. 52(8), pages 1424-1437, November.
  2. Fair Ray C, 2007. "A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best?," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 7(1), pages 1-27, June.
  3. Ray Fair, 2006. "A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best?," Yale School of Management Working Papers, Yale School of Management amz2590, Yale School of Management, revised 01 Aug 2007.
  4. Fair, Ray C., 2012. "Has macro progressed?," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 2-10.
  5. Ivrendi, Mehmet & Guloglu, Bulent, 2010. "Monetary shocks, exchange rates and trade balances: Evidence from inflation targeting countries," Economic Modelling, Elsevier, vol. 27(5), pages 1144-1155, September.

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