The Federal Reserve s implicit inflation target and Macroeconomic dynamics. A SVAR analysis

This paper identifies shocks to the Federal Reserve's inflation target as VAR innovations that make the largest contribution to future movements in long-horizon inflation expectations. The effectiveness of this scheme is documented via Monte-Carlo experiments. The estimated impulse responses indicate that a positive shock to the target is associated with a large increase in inflation and long-term interest rates in the US and the industrialised world. Target shocks are estimated to be a vital factor behind the increase in inflation during the pre-1980 period and are an important driver of the decline in long-term interest rates over the last two decades.