Forward-looking Behaviour and Credibility: Some Evidence and Implications for Policy
AbstractWhether people form their expectations of the future in a model-consistent or extrapolative manner, has implications for the way the economy and monetary policy are modelled. The first half of this paper provides three pieces of information about inflation expectations – that survey measures of expectations are inconsistent with rational expectations, but less so for financial markets than households; that actual and expected inflation interact with each other; and that the foreign exchange market anticipates tighter monetary policy when inflation is higher than expected. The second half of the paper explores some policy implications. First, the variability of inflation and output is lower when policy-makers respond to model-based forecasts, rather than just current values, of inflation and output. Second, model-consistent behaviour elsewhere in the economy stabilises inflation and output, given that the model includes a central bank reaction function which the public believes the bank will adhere to. When inflation expectations differ between groups, the ex ante real interest rates that affect output and the exchange rate differ from each other, and this can induce oscillations or overshooting in the exchange rate, with consequences for the variability of inflation and output. Third, ‘optimal’ policy cannot fully compensate for the greater variability in inflation and output associated with extrapolative expectations.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9803.
Date of creation: Feb 1998
Date of revision:
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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.:
- Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
- David Gruen & Geoffrey Shuetrim, 1994. "Internationalisation and the Macroeconomy," RBA Annual Conference Volume, in: Philip Lowe & Jacqueline Dwyer (ed.), International Intergration of the Australian Economy Reserve Bank of Australia.
- Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
- Bernanke, Ben S & Woodford, Michael, 1997.
"Inflation Forecasts and Monetary Policy,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 29(4), pages 653-84, November.
- Cochrane, John H., 1998.
"What do the VARs mean? Measuring the output effects of monetary policy,"
Journal of Monetary Economics,
Elsevier, vol. 41(2), pages 277-300, April.
- John H. Cochrane, 1995. "What do the VARs Mean?: Measuring the Output Effects of Monetary Policy," NBER Working Papers 5154, National Bureau of Economic Research, Inc.
- John M. Roberts, 1994.
"Is inflation sticky?,"
Working Paper Series / Economic Activity Section
152, Board of Governors of the Federal Reserve System (U.S.).
- Guy Debelle & Glenn Stevens, 1995. "Monetary Policy Goals for Inflation in Australia," RBA Research Discussion Papers rdp9503, Reserve Bank of Australia.
- de Brouwer, Gordon & Ericsson, Neil R, 1998.
"Modeling Inflation in Australia,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 16(4), pages 433-49, October.
- Gordon de Brouwer & Neil R. Ericsson, 1995. "Modelling Inflation in Australia," RBA Research Discussion Papers rdp9510, Reserve Bank of Australia.
- Gordon de Brouwer & Neil R. Ericsson, 1995. "Modelling inflation in Australia," International Finance Discussion Papers 530, Board of Governors of the Federal Reserve System (U.S.).
- Blake, Andrew P & Westaway, Peter F, 1996. "Credibility and the Effectiveness of Inflation Targeting Regimes," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(0), pages 28-50, Suppl..
- Taylor, John B, 1980.
"Aggregate Dynamics and Staggered Contracts,"
Journal of Political Economy,
University of Chicago Press, vol. 88(1), pages 1-23, February.
- Frank Campbell & Eleanor Lewis, 1998. "What Moves Yields in Australia?," RBA Research Discussion Papers rdp9808, Reserve Bank of Australia.
- Marcela Meirelles Aurelio, 2005. "Do we really know how inflation targeters set interest rates?," Research Working Paper RWP 05-02, Federal Reserve Bank of Kansas City.
- Levin, Andrew & Wieland, Volker & Williams, John C., 2003.
"The performance of forecast-based monetary policy rules under model uncertainty,"
CFS Working Paper Series
2003/06, Center for Financial Studies (CFS).
- Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
- Andrew Levin & Volker Wieland & John Williams, 2000. "The Performance Of Forecast-Based Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 2000 203, Society for Computational Economics.
- Andrew Levin & John C. Williams, 2000. "The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty," Econometric Society World Congress 2000 Contributed Papers 1781, Econometric Society.
- Williams, John C. & Levin, Andrew T. & Wieland, Volker, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Working Paper Series 0068, European Central Bank.
- Andrew Levin & Volker Wieland & John C. Williams, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Finance and Economics Discussion Series 2001-39, Board of Governors of the Federal Reserve System (U.S.).
- Kevin X.D. Huang & Qinglai Meng, 2007.
"Is Forward-Looking Inflation Targeting Destabilizing? The Role of Policy's Response to Current Output under Endogenous Investment,"
Vanderbilt University Department of Economics Working Papers
0704, Vanderbilt University Department of Economics.
- Huang, Kevin X.D. & Meng, Qinglai & Xue, Jianpo, 2009. "Is forward-looking inflation targeting destabilizing? The role of policy's response to current output under endogenous investment," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 409-430, February.
- Kevin Lee & Nilss Olekalns & Kalvinder Shields, 2012.
"Meta Taylor Rules for the UK and Australia; Accommodating Regime Uncertainty in Monetary Policy Analysis using Model Averaging Methods,"
Department of Economics - Working Papers Series
1138, The University of Melbourne.
- Kevin Lee & Nilss Olekalns & Kalvinder Shields, 2013. "Meta Taylor Rules for the UK and Australia; Accommodating Regime Uncertainty in Monetary Policy Analysis Using Model Averaging Methods," Manchester School, University of Manchester, vol. 81, pages 28-53, October.
- David Hargreaves, 1999. "SDS-FPS: a small demand-side version of the Forecasting and Policy System core model," Reserve Bank of New Zealand Discussion Paper Series G99/10, Reserve Bank of New Zealand.
- West, L.k. & Agbola, W.F., 2005. "Causality Links Between Asset Prices And Cash Rate In Australia," International Journal of Applied Econometrics and Quantitative Studies, Euro-American Association of Economic Development, vol. 2(3), pages 69-86.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Paula Drew).
If references are entirely missing, you can add them using this form.