Learning About the Term Structure and Optimal Rules for Inflation Targeting

40 Pages Posted: 28 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)

Eric Schaling

Rand Afrikaans University - Department of Economics; Bank of England

M. F. Tesfaselassie

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: October 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

Eijffinger, Sylvester C. W. and Schaling, Eric and tesfaselassie, mewael F., Learning About the Term Structure and Optimal Rules for Inflation Targeting (October 2006). CEPR Discussion Paper No. 5896. Available at SSRN: https://ssrn.com/abstract=954002

Sylvester C. W. Eijffinger (Contact Author)

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

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CESifo (Center for Economic Studies and Ifo Institute)

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Centre for Economic Policy Research (CEPR)

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Eric Schaling

Rand Afrikaans University - Department of Economics ( email )

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Bank of England

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Mewael F. Tesfaselassie

affiliation not provided to SSRN ( email )

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