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Monetary Policy, Nominal Interest Rates, and Long-horizon Inflation Uncertainty

  • Wright, Stephen

Empirical evidence presented in this paper shows that the predictability of inflation at long horizons varies considerably across countries. Both simple theory and empirical evidence suggest that the crucial factor is the extent to which systematic monetary policy succeeds in stabilising the incipient unit root in inflation. The mechanism by which it does this appears, however, to be complicated by strong empirical evidence that nominal interest rates have real effects, which implies that monetary policy need not be so vigorous in reaction to inflation. This helps explain why inflation rates in the US and (especially) Germany have been relatively predictable, despite monetary policy rules which appear to have been barely stabilising. The paper also presents tentative evidence that the power of nominal interest rate effects is inversely related to long-horizon inflation uncertainty, and hence ultimately uncertainty about monetary policy.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 9820.

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Date of creation: Oct 1998
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Handle: RePEc:cam:camdae:9820
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  1. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  2. Bernanke, Ben S. & Mihov, Ilian, 1998. "The liquidity effect and long-run neutrality," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 149-194, December.
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