Estimating the Revealed Inflation Target: An Application to U.S. Monetary Policy

Daniel Leigh ()
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Daniel Leigh: European International Monetary Fund

No 177, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper proposes a new method of estimating the Taylor rule with a time-varying implicit inflation target and a time-varying natural rate of interest. The inflation target and the natural rate are modelled as random walks and are estimated using maximum likelihood and the Kalman filter. I apply this method to U.S. monetary policy over the last 25 years to understand how the Federal Reserve’s target has varied during this broadly successful period. Stability tests indicate significant time variation in the implicit target. In the early 1980s, during the Volcker disinflation, the inflation target is near 3%. In the late 1980s and early 1990s, the target is close to actual inflation of 3-4% and only declines once the 1990-91 recession reduces inflation to 1-2%, corroborating historical evidence of an “opportunistic approach to disinflation.†Finally, over 2001-2004, the target rises to 2-3%, behaviour that can be interpreted as a response the risks of hitting the zero bound on nominal interest rates

Keywords: Taylor rule; time-varying parameters; Kalman filter (search for similar items in EconPapers)
JEL-codes: C22 E31 E52 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:sce:scecf5:177

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