What Does the Yield Curve Tell Us about the Federal Reserve's Implicit Inflation Target?
Federal Reserve Bank of Kansas City
December 1, 2007
FRB of Kansas City Research Working Paper 07-10
This paper studies the time variation of the Federal Reserve's inﬂation target between 1960 and 2004 using both macro and yield curve data. I estimate a New Keynesian dynamic stochastic general equilibrium model in which the inﬂation target follows a random-walk process. I compare estimation results obtained from both macroeconomic and yield curve data, two estimates obtained with only macro data, in order to determine what the yield curve tells us about the inﬂation target. In the joint estimation, the estimated inﬂation target is much higher during the mid 1980s than in the corresponding macro estimation. Also, some part of the decline in the inﬂation target during the early or the mid 1980s seems to be perceived as temporary when private agents have to ﬁlter out the random walk part of the inﬂation target from the composite inﬂation target. My ﬁndings suggest that ﬁnancial market participants were skeptical of the Fed's commitment to low inﬂation even after the Volcker disinﬂation period of the early 1980s.
Number of Pages in PDF File: 35
Keywords: Inflation targeting, DSGE model, term structure of interest rates
JEL Classification: C32, E43, G12working papers series
Date posted: December 19, 2007 ; Last revised: March 5, 2013
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