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Learning About the Term Structure and Optimal Rules for Inflation Targeting

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  • Mewael F. Tesfaselassie
  • Eric Schaling
  • Sylvester Eijffinger

Abstract

n 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 Economic Research Southern Africa in its series Working Papers with number 62.

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Date of creation: 2007
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Handle: RePEc:rza:wpaper:62

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References

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  1. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers, Department of Economics, University of York 00/41, Department of Economics, University of York.
  2. Bullard, James & Schaling, Eric, 2006. "Monetary policy, determinacy, and learnability in the open economy," Working Paper Series, European Central Bank 0611, European Central Bank.
  3. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers, Stockholm - International Economic Studies 615, Stockholm - International Economic Studies.
  4. Thomas Sargent & Noah Williams & Tao Zha, 2009. "The Conquest of South American Inflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 117(2), pages 211-256, 04.
  5. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(1), pages 153-171, August.
  6. Eric Schaling, James Bullard, 2001. "New economy : new policy rules?," Computing in Economics and Finance 2001, Society for Computational Economics 53, Society for Computational Economics.
  7. 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, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 571-86, August.
  8. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  9. 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.
  10. Rudebusch, Glenn & Svensson, Lars, 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," Seminar Papers, Stockholm University, Institute for International Economic Studies 672, Stockholm University, Institute for International Economic Studies.
  11. 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, Bank of Finland 23/2004, Bank of Finland.
  12. Tesfaselassie, M.F., 2005. "Communication, Learning and Optimal Monetary Policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-173210, Tilburg University.
  13. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4135, C.E.P.R. Discussion Papers.
  14. Schaling, E., 1998. "The Nonlinear Phillips Curve and Inflation Forecast Targeting - Symmetric Versus Asymmetric Monetary Policy Rules," Discussion Paper, Tilburg University, Center for Economic Research 1998-136, Tilburg University, Center for Economic Research.
  15. Pollock, D. S. G., 2003. "Recursive estimation in econometrics," Computational Statistics & Data Analysis, Elsevier, Elsevier, vol. 44(1-2), pages 37-75, October.
  16. Yetman, James, 2000. "Probing Potential Output: Monetary Policy, Credibility, and Optimal Learning under Uncertainty," Working Papers, Bank of Canada 00-10, Bank of Canada.
  17. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  18. 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.
  19. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series, European Central Bank 0539, European Central Bank.
  20. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1998. "The Term Structure of Interest Rates and Inflation Forecast Targeting," Discussion Paper, Tilburg University, Center for Economic Research 1998-85, Tilburg University, Center for Economic Research.
  21. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers, Queen Mary, University of London, School of Economics and Finance 462, Queen Mary, University of London, School of Economics and Finance.
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Citations

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Cited by:
  1. Tesfaselassie, M.F. & Schaling, E., 2010. "Managing disinflation under uncertainty," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(12), pages 2568-2577, December.
  2. 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, Central Bank of Chile, 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.
  3. Eric Schaling & Marco Hoeberichts, 2010. "Why Speed Doesn’t Kill: Learning to Believe in Disinflation," De Economist, Springer, Springer, vol. 158(1), pages 23-42, April.
  4. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.
  5. repec:nbr:nberwo:13892 is not listed on IDEAS
  6. 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.
  7. 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.
  8. Williams, Noah, 2012. "Monetary policy under financial uncertainty," Journal of Monetary Economics, Elsevier, Elsevier, vol. 59(5), pages 449-465.
  9. D.A. Kendrick & H.M. Amman & M.P. Tucci, 2008. "Learning About Learning in Dynamic Economic Models," Working Papers, Utrecht School of Economics 08-20, Utrecht School of Economics.

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