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Strict and Flexible Inflation Forecast Targets: An Empirical Investigation

We examine whether models of inflation forecast targeting are consistent with the observed behaviour of the central banks of Australia, Canada, and the United States. The target criteria from these models restrict the conditionally expected paths of variables targeted by the central bank, in particular inflation and the output gap. We estimate various moment conditions, providing a description of monetary policy for each central bank under different maintained hypotheses. We then test whether these estimated conditions satisfy the predictions of models of optimal monetary policy. The overall objective is to examine the extent to which and the manner in which these central banks successfully balance inflation and output objectives over the near term. For all three countries, we obtain reasonable estimates for both the strict and flexible inflation forecast targeting models, though with some qualifications. Most notably, for Australia and the United States there are predictable deviations from forecasted targets, which is not consistent with models of inflation targeting. In contrast, the results for Canada lend considerable support to simple models of flexible inflation forecast targeting.

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Paper provided by Department of Economics, University of Victoria in its series Department Discussion Papers with number 0902.

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Length: 48 pages
Date of creation: 16 Jun 2009
Date of revision:
Handle: RePEc:vic:vicddp:0902
Note: ISSN 1914-2838
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Web page: http://web.uvic.ca/econ

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  1. Nicholas Rowe & James Yetman, 2002. "Identifying a policymaker's target: an application to the Bank of Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 35(2), pages 239-256, May.
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  3. Michael Woodford, 2007. "Forecast Targeting as a Monetary Policy Strategy: Policy Rules in Practice," NBER Working Papers 13716, National Bureau of Economic Research, Inc.
  4. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  5. Bennett T. McCallum, 2000. "The Present and Future of Monetary Policy Rules," NBER Working Papers 7916, National Bureau of Economic Research, Inc.
  6. Jeremy B. Rudd & Karl Whelan, 2005. "Modelling inflation dynamics: a critical review of recent research," Finance and Economics Discussion Series 2005-66, Board of Governors of the Federal Reserve System (U.S.).
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  8. Bennett T. McCallum & Edward Nelson, 2004. "Targeting vs. instrument rules for monetary policy," Working Papers 2004-011, Federal Reserve Bank of St. Louis.
  9. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  10. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  11. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  12. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
  13. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  14. Richard Dennis, 2003. "Inferring policy objectives from economic outcomes," Working Paper Series 2003-05, Federal Reserve Bank of San Francisco.
  15. Kenneth N. Kuttner, 2004. "The role of policy rules in inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 89-112.
  16. John Shea, 1997. "Instrument Relevance in Multivariate Linear Models: A Simple Measure," The Review of Economics and Statistics, MIT Press, vol. 79(2), pages 348-352, May.
  17. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  18. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  19. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  20. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  21. Michael Woodford, 2004. "Inflation targeting and optimal monetary policy," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 15-42.
  22. Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-29, October.
  23. Richard Dennis, 2006. "The policy preferences of the US Federal Reserve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 55-77.
  24. Lars E. O. Svensson, 2005. "Targeting versus instrument rules for monetary policy: what is wrong with McCallum and Nelson?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 613-626.
  25. S. G. B Henry & A. R. Pagan, 2004. "The Econometrics of the New Keynesian Policy Model: Introduction," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 581-607, 09.
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  27. repec:ucp:bknber:9780226044712 is not listed on IDEAS
  28. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 225-245.
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