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Learning About the Term Structure and Optimal Rules for Inflation Targeting

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  • Tesfaselassie, M.F.
  • Schaling, E.
  • Eijffinger, S.C.W.

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 Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam in its series ERIM Report Series Research in Management with number ERS-2006-058-F&A.

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Date of creation: 30 Oct 2006
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Handle: RePEc:ems:eureri:8042

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Postal: RSM Erasmus University & Erasmus School of Economics, PoBox 1738, 3000 DR Rotterdam
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Web page: http://www.erim.eur.nl/
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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. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The conquest of South American inflation," Working Paper 2006-20, Federal Reserve Bank of Atlanta.
  2. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers 462, Queen Mary, University of London, School of Economics and Finance.
  3. 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.
  4. Tesfaselassie, M.F., 2005. "Communication, Learning and Optimal Monetary Policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-173210, Tilburg University.
  5. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  6. Rudebusch, Glenn D & Svensson, Lars E O, 2000. "Eurosystem Monetary Targeting: Lessons from US Data," CEPR Discussion Papers 2522, C.E.P.R. Discussion Papers.
  7. Svensson, Lars E O, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," CEPR Discussion Papers 1511, C.E.P.R. Discussion Papers.
  8. James B. Bullard & Eric Schaling, 2001. "New economy-new policy rules," Review, Federal Reserve Bank of St. Louis, issue May, pages 57-66.
  9. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  10. Pollock, D. S. G., 2003. "Recursive estimation in econometrics," Computational Statistics & Data Analysis, Elsevier, vol. 44(1-2), pages 37-75, October.
  11. James Bullard & Eric Schaling, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Working Papers 11, Economic Research Southern Africa.
  12. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
  13. 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.
  14. 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.
  15. 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.
  16. 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.
  17. 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.
  18. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August.
  19. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  20. 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.
  21. 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.
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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. 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.
  3. Williams, Noah, 2012. "Monetary policy under financial uncertainty," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 449-465.
  4. Lars E.O. Svensson & Noah M. Williams, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," NBER Working Papers 13414, National Bureau of Economic Research, Inc.
  5. Tesfaselassie, M.F. & Schaling, E., 2010. "Managing disinflation under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 34(12), pages 2568-2577, December.
  6. 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.
  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. 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.
  9. repec:nbr:nberwo:13892 is not listed on IDEAS

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