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Estimating the Revealed Inflation Target: An Application to U.S. Monetary Policy

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  • Daniel Leigh

    (European International Monetary Fund)

Abstract

This paper proposes a new method of estimating the Taylor rule with a time-varying implicit inflation target and a time-varying natural rate of interest. The inflation target and the natural rate are modelled as random walks and are estimated using maximum likelihood and the Kalman filter. I apply this method to U.S. monetary policy over the last 25 years to understand how the Federal Reserve’s target has varied during this broadly successful period. Stability tests indicate significant time variation in the implicit target. In the early 1980s, during the Volcker disinflation, the inflation target is near 3%. In the late 1980s and early 1990s, the target is close to actual inflation of 3-4% and only declines once the 1990-91 recession reduces inflation to 1-2%, corroborating historical evidence of an “opportunistic approach to disinflation.†Finally, over 2001-2004, the target rises to 2-3%, behaviour that can be interpreted as a response the risks of hitting the zero bound on nominal interest rates

Suggested Citation

  • Daniel Leigh, 2005. "Estimating the Revealed Inflation Target: An Application to U.S. Monetary Policy," Computing in Economics and Finance 2005 177, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:177
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    File URL: http://repec.org/sce2005/up.10807.1106941375.pdf
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    References listed on IDEAS

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    10. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November.
    11. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    12. Douglas O. Staiger & James H. Stock & Mark W. Watson, 1997. "How Precise Are Estimates of the Natural Rate of Unemployment?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 195-246, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Paulo Chananeco F. de Barcellos Neto & Marcelo Savino Portugal, 2006. "The Natural Rate Of Interest In Brazil Between 1999 And 2005," Anais do XXXIV Encontro Nacional de Economia [Proceedings of the 34th Brazilian Economics Meeting] 84, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].

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    More about this item

    Keywords

    Taylor rule; time-varying parameters; Kalman filter;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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