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Forward-Looking Rules for Monetary Policy

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Author Info
Andrew G. Haldane
Nicoletta Batini

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Abstract

This paper evaluates a class of simple monetary policy rules which feed back from explicit forecasts of future inflation - inflation forecast-based (IFB) rules. These rules aim to mimic current monetary policy practices among the inflation-targeting countries, where policy decisions are based on inflation forecasts. The rules themselves are evaluated using simulations from a small, rational expectations, open-economy macro-model. IFB rules are found to perform well in comparison with other simple rules, such as the Taylor rule. The reasons for this are: first, because they embody the lags in monetary transmission, aligning explicitly the control and the feedback variables of the policymaker; second, because IFB rules are capable of smoothing output by as much as is possible with rules which target output directly - for example, through variations in the forecast horizon; and third, because IFB rules implicitly condition on all state variables, and thus are information-efficient. For these reasons, inflation-targeting rules with an explicitly forward-looking dimension are found to take us within reach of the fully-optimal rule.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6543.

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Date of creation: May 1998
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Handle: RePEc:nbr:nberwo:6543

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