Heterogeneous information about the term structure of interest rates, least-squares learning and optimal interest rate rules for inflation forecast targeting
In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. Learning about the transmission process of monetary policy is introduced by having heterogeneous agents - i.e. the central bank and private agents - who have different information sets about the future sequence of short-term interest rates. We analyse inflation forecast targeting in two environments. One in which the central bank has perfect knowledge, in the sense that it understands and observes the process by which private sector interest rate expectations are generated, and one in which the central bank has imperfect knowledge and has to learn the private sector forecasting rule for short-term interest rates. In the case of imperfect knowledge, the central bank has to learn about private sector interest rate expectations, as the latter affect the impact of monetary policy through the expectations theory of the term structure of interest rates. Here following Evans and Honkapohja (2001), the learning scheme we investigate is that of least-squares learning (recursive OLS) using the Kalman filter. We find that optimal monetary policy under learning is a policy that separates estimation and control. Therefore, this model suggests that the practical relevance of the breakdown of the separation principle and the need for experimentation in policy may be limited.
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Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number
14.
Find related papers by JEL classification: C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications 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 F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
James B. Bullard & Eric Schaling, 2001.
"New economy-new policy rules,"
Review,
Federal Reserve Bank of St. Louis, issue May, pages 57-66.
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