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Are Constant Interest Rate Forecasts Modest Policy Interventions? Evidence from a Dynamic Open-Economy Model

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  • Malin Adolfson
  • Stefan Laséen
  • Jesper Lindé
  • Mattias Villani

Abstract

This paper uses an estimated open-economy dynamic stochastic general equilibrium model for the euro area to examine if during 1993Q4-2002Q4 constant interest rate forecasts (CIRFs), commonly used by inflation-targeting central banks, are viewed as being in line with the central bank's historical policy behaviour. In the sense of Leeper and Zha (2003), a CIRF is defined as a modest intervention of the policy rule if it does not trigger the agents to revise their expectations about the inflation-targeting policy. Using univariate modesty statistics, we show that the modesty of the policy interventions depends on the assumptions about the uncertainty in the future shock realizations. Taking the joint effects of the policy interventions on all variables into consideration, we find that the CIRFs are not modest policy interventions in the latter part of the sample (1998Q4-2002Q4), and thereby affect the expectations formation of the agents. Consequently, the constant interest rate assumption has arguably led to conditional forecasts at the two-year horizon that cannot be considered economically meaningful during this period, and should not be used as a communication device by inflation-targeting central banks. Copyright Blackwell Publishing Ltd. 2005

Suggested Citation

  • Malin Adolfson & Stefan Laséen & Jesper Lindé & Mattias Villani, 2005. "Are Constant Interest Rate Forecasts Modest Policy Interventions? Evidence from a Dynamic Open-Economy Model," International Finance, Wiley Blackwell, vol. 8(3), pages 509-544, December.
  • Handle: RePEc:bla:intfin:v:8:y:2005:i:3:p:509-544
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    Citations

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    Cited by:

    1. Malin Adolfson & Michael K. Andersson & Jesper Lindé & Mattias Villani & Anders Vredin, 2007. "Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks," International Journal of Central Banking, International Journal of Central Banking, vol. 3(4), pages 111-144, December.
    2. Pär Osterholm, 2009. "Incorporating Judgement in Fan Charts," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(2), pages 387-415, June.
    3. repec:spr:empeco:v:53:y:2017:i:4:d:10.1007_s00181-016-1175-4 is not listed on IDEAS
    4. Knüppel, Malte & Schultefrankenfeld, Guido, 2013. "The empirical (ir)relevance of the interest rate assumption for central bank forecasts," Discussion Papers 11/2013, Deutsche Bundesbank.
    5. Farooq Akram & Andrew Binning & Junior Maih, 2016. "Joint Prediction Bands for Macroeconomic Risk Management," Working Papers No 5/2016, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
    6. Harrison, Ricahrd, 2014. "Estimating the effects of forward guidance in rational expectations models," LSE Research Online Documents on Economics 86327, London School of Economics and Political Science, LSE Library.
    7. Harrison, Richard, 2015. "Estimating the effects of forward guidance in rational expectations models," European Economic Review, Elsevier, vol. 79(C), pages 196-213.
    8. Christian Bustamante & Luis E. Rojas, 2012. "Constant-Interest-Rate Projections and Its Indicator Properties," Borradores de Economia 696, Banco de la Republica de Colombia.
    9. Christoffel, Kai & Coenen, Gunter & Warne, Anders, 2007. "Conditional versus unconditional forecasting with the New Area-Wide Model of the euro area," MPRA Paper 76759, University Library of Munich, Germany.

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