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Uncovering Financial Markets Beliefs About Inflation Targets

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  • RUGE-MURCIA, Francisco J.

Abstract

This paper exploits the term structure of interest rates to develop testable economic restrictions on the joint process of long-term interest rates and inflation when the latter is subject to a targeting policy by the Central Bank. Two competing models that econometrically describe agents’ inferences about inflation targets are developed and shown to generate distinct predictions on the behavior of interest rates. In an empirical application to the Canadian inflation target zone, results indicate that agents perceive the band to be substantially narrower than officially announced and asymmetric around the stated mid-point. The latter result (i) suggests that the monetary authority attaches different weights to positive and negative deviations from the central target, and (ii) challenges on empirical grounds the assumption, frequently made in the literature, that the policy maker’s loss function is symmetric (usually a quadratic function) around a desired inflation value.

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File URL: http://hdl.handle.net/1866/454
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Bibliographic Info

Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 9803.

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Length: 37 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:mtl:montde:9803

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Keywords: inflation targets; credibility; asymmetries; nonlinear rational exctations models;

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References

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Citations

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Cited by:
  1. RUGE-MURCIA, Francisco J., 2001. "A Prudent Central Banker," Cahiers de recherche 2001-07, Universite de Montreal, Departement de sciences economiques.
  2. St-Amant, Pierre & Tessier, David, 1998. "Résultats empiriques multi-pays relatifs à l'impact des cibles d'inflation sur la crédibilité de la politique monétaire," Working Papers 98-23, Bank of Canada.
  3. Capistrán, Carlos, 2008. "Bias in Federal Reserve inflation forecasts: Is the Federal Reserve irrational or just cautious?," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1415-1427, November.
  4. RUGE-MURCIA, Francisco J., 2002. "Some Implications of the Zero Lower Bound on Interest Rates for the Term Structure and Monetary Policy," Cahiers de recherche 2002-06, Universite de Montreal, Departement de sciences economiques.
  5. Francisco J. Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," Banco de Espa�a Working Papers 0106, Banco de Espa�a.
  6. Kevin Aretz & David Peel, 2007. "Some implications of a quartic loss function," Economics Bulletin, AccessEcon, vol. 7(13), pages 1-7.
  7. repec:ebl:ecbull:v:7:y:2007:i:13:p:1-7 is not listed on IDEAS
  8. Diana N. Weymark, 2001. "Inflation Targeting, Announcements, and Imperfect Credibility," Vanderbilt University Department of Economics Working Papers 0124, Vanderbilt University Department of Economics, revised Apr 2002.
  9. Perrier, Patrick, 1998. "Un examen de la crédibilité de la politique monétaire au Canada," Working Papers 98-12, Bank of Canada.
  10. Oleg Korenok & Stanislav Radchenko, 2005. "Expectations Anchoring in Inflation Targeting Regimes," Working Papers 0503, VCU School of Business, Department of Economics.

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