Learning About the Term Structure and Optimal Rules for Inflation Targeting

43 Pages Posted: 23 Dec 2006

See all articles by Sylvester C. W. Eijffinger

Sylvester C. W. Eijffinger

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

E. Schaling

Tilburg University, CentER

M. F. Tesfaselassie

affiliation not provided to SSRN

Date Written: October 30, 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

Suggested Citation

Eijffinger, Sylvester C. W. and Schaling, E. and tesfaselassie, mewael F., Learning About the Term Structure and Optimal Rules for Inflation Targeting (October 30, 2006). ERIM Report Series Reference No. ERS-2006-058-F&A. Available at SSRN: https://ssrn.com/abstract=942153

Sylvester C. W. Eijffinger (Contact Author)

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

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2411 (Phone)
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CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

E. Schaling

Tilburg University, CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 8205 (Phone)

Mewael F. Tesfaselassie

affiliation not provided to SSRN ( email )

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