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Evaluating Inflation Targeting Using a Macroeconometric Model

  • Ray Fair
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    This paper uses a structurally estimated macroeconometric model, denoted the MC model, to evaluate inflation targeting in the United States. Various interest rate rules are tried with differing weights on inflation and output, and various optimal control problems are solved using differing weights on inflation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to inflation targeting, especially for price shocks, 2) price-level targeting is dominated by inflation targeting, 3) the estimated interest rate rule of the Fed (in Table 4) is consistent with the Fed placing equal weights on inflation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past.

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    Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number amz2483.

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    Date of creation: 01 Jul 2006
    Date of revision: 01 Aug 2007
    Handle: RePEc:ysm:somwrk:amz2483
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