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Inflation-Forecast-Based Rules and Indeterminacy: A Puzzle and a Resolution

Levine, P, McAdam, P and Pearlman, J (2007) Inflation-Forecast-Based Rules and Indeterminacy: A Puzzle and a Resolution International Journal of Central Banking, 3 (4). pp. 77-110.

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We examine an interesting puzzle in monetary economics between what monetary authorities claim (namely, to be forward looking and preemptive) and the poor stabilization properties routinely reported for forecast-based rules. Our resolution is that central banks should be viewed as following 'Calvo-type' inflation-forecast-based (IFB) interest rate rules that depend on a discounted sum of current and future rates of inflation. Such rules might be regarded as both within the legal frameworks and potentially mimicking central bankers' practice. We find that Calvo-type IFB interest rate rules are, first, less prone to indeterminacy than standard rules with a finite forward horizon. Second, in difference form, the indeterminacy problem disappears altogether. Third, optimized forms have good stabilization properties as they become more forward looking, a property that sharply contrasts that of standard IFB rules. Fourth, they appear data coherent when incorporated into a well-known estimated dynamic stochastic general equilibrium (DSGE) model of the euro area.

Item Type: Article
Divisions : Surrey research (other units)
Authors :
McAdam, P
Pearlman, J
Date : 1 December 2007
Uncontrolled Keywords : E52, E37, E58
Depositing User : Symplectic Elements
Date Deposited : 16 May 2017 15:14
Last Modified : 24 Jan 2020 14:09

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