Inflation Forecast Targeting: A VAR Approach

We show how to implement inflation forecast targeting using a VAR model and derive the implied inflation-output variability frontier. Our approach is based on dynamic, stochastic simulations of the average inflation rate over a two-year horizon using the moving average representation of the VAR model. Using real time data over two samples, we estimate the inflation-output variability frontier for the U.S. and show that it has shifted favorably over time. We consider the frequency and nature of the policy interventions required to achieve target inflation in both samples and compare these interventions over time.

Estimating the Inflation-Output Variability Frontier with Inflation Targeting: A VAR Approach

This paper (i) illustrates how a VAR model can be used to evaluate inflation targeting, (ii) derives the policy frontier available to the central bank using counterfactual experiments with real time data, and (iii) estimates how this frontier has changed over time in terms of the position and slope of the available tradeoff between output gap variability and inflation variability under inflation targeting. Various inflation targets are considered as are tolerance bands of varying width around these targets. The results indicate that over time (i) a given reduction in inflation variability is associated with a smaller rise in output variability and that (ii) a given inflation variability is achieved with smaller interest rate volatility. Consistent with the data, our results require federal funds rate persistence, though no instrument instability was observed.

Estimating the Inflation-Output Variability Frontier with Inflation Targeting: A VAR Approach

This paper (i) illustrates how a VAR model can be used to evaluate inflation targeting, (ii) derives the policy frontier available to the central bank using counterfactual experiments with real time data, and (iii) estimates how this frontier has changed over time in terms of the position and slope of the available tradeoff between output gap variability and inflation variability under inflation targeting. Various inflation targets are considered as are tolerance bands of varying width around these targets. The results indicate that over time (i) a given reduction in inflation variability is associated with a smaller rise in output variability and that (ii) a given inflation variability is achieved with smaller interest rate volatility. Consistent with the data, our results require federal funds rate persistence, though no instrument instability was observed. One interpretation of these results is that they reflect the growing credibility of the Federal Reserve.

Interwar Price Level Targeting

Fackler and Parker argue that the Great Depression may have been preventable with a formalized policy rule proposed by economist Irving Fisher. Policymakers have an ongoing debate about whether formalized policy rules are better than discretionary policy decisions for economic outcomes. The authors’ analysis suggests that in the case of the Great Depression, if Fisher’s policy rule had been adopted in 1930 the collapse of the economy would have been avoided

Nominal GDP versus Price Level Targeting: An Empirical Evaluation

In response to the ongoing discussion in the literature of the appropriate framework for monetary policy, we compare two of the most frequently discussed alternatives to inflation targeting—targeting either the level of nominal GDP or the price level—within the context of a simple vector autoregressive (VAR) model. Our approach can be considered a constrained-discretion approach. The model is estimated using quarterly data over the period 1979:4-2003:4, a period in which the economy was buffeted by substantial supply and demand shocks. The paths of the federal funds rate, nominal GDP, real GDP, and the price level under nominal GDP and price level targeting are simulated over the 2004:1-2006:4 period. We evaluate nominal GDP and price level targeting by computing the values of simple loss functions. The loss function values indicate that closely targeting the path of nominal GDP based on 4.5% desired growth in nominal GDP produces noticeably lower losses in the simulation period than either price level targeting or a continuation of the implicit flexible inflation targeting monetary policy that characterized the estimation period

Should the Federal Reserve continue to monitor credit?

The erratic behavior of credit aggregates in recent years has led to questions about whether any credit measure is useful in conducting monetary policy. Empirical evidence suggests that the private component of total credit may provide useful information to monetary policymakers.Credit ; Monetary policy - United States