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Learning About the Term Structure and Optimal Rules for Inflation Targeting

  • Tesfaselassie, M.F.
  • Schaling, E.
  • Eijffinger, S.C.W.

In 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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File URL: http://repub.eur.nl/pub/8042/ERS-2006-058-F&A.pdf
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Paper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam in its series ERIM Report Series Research in Management with number ERS-2006-058-F&A.

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Date of creation: 30 Oct 2006
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Handle: RePEc:ems:eureri:8042
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  2. Eric Schaling & James Bullard, 2005. "Monetary Policy, Determinacy, and Learnability in the Open Economy," Computing in Economics and Finance 2005 362, Society for Computational Economics.
  3. James Yetman, 2000. "Probing Potential Output: Monetary Policy, Credibility And Optimal Learning Under Uncertainty," Computing in Economics and Finance 2000 181, Society for Computational Economics.
  4. Glenn D. Rudebusch & Lars E.O. Svensson, 1999. "Eurosystem Monetary Targeting: Lessons from U.S. Data," NBER Working Papers 7179, National Bureau of Economic Research, Inc.
  5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  6. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
  7. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive Learning, Persistence, and Optimal Monetary Policy," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 376-385, 04-05.
  8. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  9. Schaling, Eric, 2004. "The Nonlinear Phillips Curve and Inflation Forecast Targeting: Symmetric versus Asymmetric Monetary Policy Rules," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 361-86, June.
  10. Stephen Pollock, 2002. "Recursive Estimation in Econometrics," Working Papers 462, Queen Mary University of London, School of Economics and Finance.
  11. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  12. Eijffinger, S.C.W. & Schaling, E. & Verhagen, W.H., 1998. "The Term Structure of Interest Rates and Inflation Forecast Targeting," Discussion Paper 1998-85, Tilburg University, Center for Economic Research.
  13. 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, vol. 30(3), pages 571-86, August.
  14. James B. Bullard & Eric Schaling, 2006. "Monetary policy, determinacy, and learnability in a two-block world economy," Working Papers 2006-038, Federal Reserve Bank of St. Louis.
  15. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  16. Eric Schaling, James Bullard, 2001. "New economy : new policy rules?," Computing in Economics and Finance 2001 53, Society for Computational Economics.
  17. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  18. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  19. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, June.
  20. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August.
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  22. 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.
  23. 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 23/2004, Bank of Finland.
  24. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
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