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Performance of Inflation Targeting Based on Constant Interest Rate Projections

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  • Honkapohja, Seppo
  • Mitra, Kaushik

Abstract

Monetary policy is sometimes formulated in terms of a target level of inflation, a fixed time horizon and a constant interest rate that is anticipated to achieve the target at the specified horizon. These requirements lead to constant interest rate (CIR) instrument rules. Using the standard New Keynesian model, it is shown that some forms of CIR policy lead to both indeterminacy of equilibria and instability under adaptive learning. Some other forms of CIR policy perform better, however. We also examine the properties of the different policy rules in the presence of inertial demand and price behaviour.

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  • Honkapohja, Seppo & Mitra, Kaushik, 2003. "Performance of Inflation Targeting Based on Constant Interest Rate Projections," CEPR Discussion Papers 4126, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4126
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    Cited by:

    1. Galí, Jordi, 2011. "Are central banks' projections meaningful?," Journal of Monetary Economics, Elsevier, vol. 58(6), pages 537-550.
    2. Woodford, Michael, 2013. "Forward Guidance by Inflation-Targeting Central Banks," CEPR Discussion Papers 9722, C.E.P.R. Discussion Papers.
    3. Cole, Stephen J. & Martínez-García, Enrique, 2023. "The effect of central bank credibility on forward guidance in an estimated New Keynesian model," Macroeconomic Dynamics, Cambridge University Press, vol. 27(2), pages 532-570, March.
    4. repec:zbw:bofrdp:2007_032 is not listed on IDEAS
    5. Michael Woodford, 2012. "Forecast Targeting as a Monetary Policy Strategy - Policy Rules in Practice," Book Chapters, in: Evan F. Koenig & Robert Leeson & George A. Kahn (ed.), The Taylor Rule and the Transformation of Monetary Policy, chapter 9, Hoover Institution, Stanford University.
    6. Jordi Galí, 2009. "Constant interest rate projections without the curse of indeterminacy: A note," International Journal of Economic Theory, The International Society for Economic Theory, vol. 5(1), pages 61-68, March.
    7. Arnab Bhattacharjee & Sean Holly, 2004. "Inflation Targeting, committee Decision Making and Uncertainty: The case of the Bank of England's MPC," Money Macro and Finance (MMF) Research Group Conference 2004 63, Money Macro and Finance Research Group.
    8. Alessandro Flamini, 2012. "Interest Rate Forecasts in Inflation Targeting Open-Economies," Economia politica, Società editrice il Mulino, issue 3, pages 381-408.
    9. Stephen J. Cole, 2020. "The Limits of Central Bank forward Guidance under Learning," International Journal of Central Banking, International Journal of Central Banking, vol. 16(4), pages 199-250, September.
    10. Michael Woodford, 2005. "Central bank communication and policy effectiveness," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 399-474.
    11. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076, Central Bank of Chile.
    12. Thoma, Mark, 2008. "Structural change and lag length in VAR models," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 965-976, September.
    13. Malin Adolfson & Stefan Laséen & Jesper Lindé & Mattias Villani, 2005. "Are Constant Interest Rate Forecasts Modest Policy Interventions? Evidence from a Dynamic Open‐Economy Model," International Finance, Wiley Blackwell, vol. 8(3), pages 509-544, December.
    14. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076, Central Bank of Chile.
    15. Cole, Stephen J. & Huh, Sungjun, 2024. "Measuring the effects of unconventional monetary policy tools under adaptive learning," Journal of Economic Dynamics and Control, Elsevier, vol. 164(C).
    16. Stephen J. Cole, 2021. "Learning and the Effectiveness of Central Bank Forward Guidance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(1), pages 157-200, February.
    17. Berg, Claes & Jansson, Per & Vredin, Anders, 2004. "How Useful are Simple Rules for Monetary Policy? The Swedish Experience," Working Paper Series 169, Sveriges Riksbank (Central Bank of Sweden).
    18. Bohdan Klos & Ryszard Kokoszczynski & Tomasz Lyziak & Jan Przystupa & Ewa Wrobel, 2005. "Structural Econometric Models in Forecasting Inflation at the National Bank of Poland," NBP Working Papers 31, Narodowy Bank Polski.
    19. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076, Central Bank of Chile.
    20. Bedri Kamil Onur Tas, 2007. "Inflation Targeting as a Signalling Mechanism," Working Papers 0701, TOBB University of Economics and Technology, Department of Economics.
    21. Peter Stalder, 2006. "Central Banks' Inflation Forecasts: The Problem of Conditioning on Fixed Short-Term Interest Rates," EcoMod2006 272100087, EcoMod.
    22. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Are Constant Interest Rate Forecasts Modest Interventions? Evidence from an Estimated Open Economy DSGE Model of the Euro Area," Working Paper Series 180, Sveriges Riksbank (Central Bank of Sweden).
    23. Francesco Luna, 2019. "Mr. Taylor and the Central Bank: Two Inference Exercises," IMF Working Papers 2019/033, International Monetary Fund.
    24. Hörmann, Markus & Schabert, Andreas, 2009. "An interest rate peg might be better than you think," Economics Letters, Elsevier, vol. 105(2), pages 156-158, November.

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    More about this item

    Keywords

    Indeterminacy; Instability under learning; Inflation targeting; Inertia in demand; Inflation inertia;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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