Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153077
Authors: 
Levine, Paul
McAdam, Peter
Pearlman, Joseph G.
Year of Publication: 
2006
Series/Report no.: 
ECB Working Paper 643
Abstract: 
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.
Subjects: 
Calvo-type interest rate rules
indeterminacy
Inflation-forecast-based interest rate rules
JEL: 
E52
E37
E58
Document Type: 
Working Paper

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