Inflation Forecasts and Monetary Policy

66 Pages Posted: 12 Sep 2000  

Ben S. Bernanke

Board of Governors of the Federal Reserve System

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 1997

Abstract

Proposals for 'inflation targeting' as a strategy for monetary policy leave open the important operational question of how to determine whether current policies are consistent with the long-run inflation target. An interesting possibility is that the central bank might target current private-sector forecasts of inflation, either those made explicitly by professional forecasters or those implicit in asset prices. We address the issue of existence and uniqueness of rational expectations equilibria when the central bank uses private-sector forecasts as a guide to policy actions. In a dynamic model which incorporates both sluggish price adjustment and shocks to aggregate demand and aggregate supply, we show that strict targeting of inflation forecasts is typically inconsistent with the existence of rational expectations equilibrium, and that policies approximating strict inflation-forecast targeting are likely to have undesirable properties. We also show that economies with more general forecast-based policy rules are particularly susceptible to indeterminacy of rational expectations equilibria. We conclude that, although private-sector forecasts may contain information useful to the central bank, ultimately the monetary authorities must rely on an explicit structural model of the economy to guide their policy decisions.

Suggested Citation

Bernanke, Ben S. and Woodford, Michael, Inflation Forecasts and Monetary Policy (September 1997). NBER Working Paper No. w6157. Available at SSRN: https://ssrn.com/abstract=225920

Ben S. Bernanke (Contact Author)

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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