Inflation forecast-based-rules and indeterminacy: a puzzle and a resolution

Arbeitspapier

We examine an interesting puzzle in monetary economics between what monetary authorities claim (namely to be forward-looking and pre-emptive) 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 which 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, for such rules 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 DSGE model of the Euro-area.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 643

Classification and Topics

• Classification: Wirtschaft ; Monetary Policy ; Prices, Business Fluctuations, and Cycles: Forecasting and Simulation: Models and Applications ; Central Banks and Their Policies
• Subject: Calvo-type interest rate rules ; indeterminacy ; Inflation-forecast-based interest rate rules ; Geldpolitik ; Inflationserwartung ; Zinspolitik ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Levine, Paul ; McAdam, Peter ; Pearlman, Joseph G.
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2006

Further information

• Handle: http://hdl.handle.net/10419/153077
• Last update: 10.03.2025, 11:45 AM CET