Learning About the Term Structure and Optimal Rules for Inflation Targeting

CentER Discussion Paper No. 2006-88

37 Pages Posted: 11 Oct 2006

See all articles by M. F. Tesfaselassie

M. F. Tesfaselassie

Kiel Institute for the World Economy

Eric Schaling

Rand Afrikaans University - Department of Economics; Bank of England

Sylvester C. W. Eijffinger

Tilburg University (CentER) - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2006

Abstract

In this paper we incorporate the term structure of interest rates in a standard inflation forecast targeting framework. We find that under flexible inflation targeting and uncertainty in the degree of persistence in the economy, allowing for active learning possibilities has effects on the optimal interest rate rule followed by the central bank. For a wide range of possible initial beliefs about the unknown parameter, the dynamically optimal rule is in general more activist, in the sense of responding aggressively to the state of the economy, than the myopic rule for small to moderate deviations of the state variable from its target. On the other hand, for large deviations, the optimal policy is less activist than the myopic and the certainty equivalence policies.

Keywords: Learning, Rational Expectations, Separation Principle, Term Structure of Interest Rates

JEL Classification: C53, E43, E52, F33

Suggested Citation

Tesfaselassie, Mewael F. and Schaling, Eric and Eijffinger, Sylvester C. W., Learning About the Term Structure and Optimal Rules for Inflation Targeting (June 2006). Available at SSRN: https://ssrn.com/abstract=936336 or http://dx.doi.org/10.2139/ssrn.936336

Mewael F. Tesfaselassie (Contact Author)

Kiel Institute for the World Economy ( email )

P.O. Box 4309
Kiel, Schleswig-Hosltein D-24100
Germany

Eric Schaling

Rand Afrikaans University - Department of Economics ( email )

P.O.Box 524
2006 Auckland Park
South Africa
+27 11 489 2927/7068 (Phone)
+27 11 489 3039 (Fax)

Bank of England

Threadneedle Street
London, EC2R 8AH
United Kingdom

Sylvester C. W. Eijffinger

Tilburg University (CentER) - Department of Economics ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2411 (Phone)
+31 13 466 3042 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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