Permanent and Transitory Policy Shocks in an Empirical Macro Model with Asymmetric Information

Sharon Kozicki () and Peter Tinsley
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Sharon Kozicki: Federal Reserve Bank of Kansas City

No 2003/41, CFS Working Paper Series from Center for Financial Studies

Abstract: Despite a large literature documenting that the efficacy of monetary policy depends on how inflation expectations are anchored, many monetary policy models assume: (1) the inflation target of monetary policy is constant; and, (2) the inflation target is known by all economic agents. This paper proposes an empirical specification with two policy shocks: permanent changes to the inflation target and transitory perturbations of the short-term real rate. The public sector cannot correctly distinguish between these two shocks and, under incomplete learning, private perceptions of the inflation target will not equal the true target. The paper shows how imperfect policy credibility can affect economic responses to structural shocks, including transition to a new inflation target – a question that cannot be addressed by many commonly used empirical and theoretical models. In contrast to models where all monetary policy actions are transient, the proposed specification implies that sizable movements in historical bond yields and inflation are attributable to perceptions of permanent shocks in target inflation.

Keywords: transmission mechanism; learning; policy credibility; time-varying natural rate; shifting endpoint; inflation target; term structure of interest rates (search for similar items in EconPapers)
JEL-codes: D82 D83 E43 E52 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2003-02-10
New Economics Papers: this item is included in nep-mac and nep-mon
Note: An earlier version was presented at the 2003 conference on "Expectations, Learning, and Monetary Policy" sponsored by the Center for Financial Studies, the Deutsche Bundesbank, and the Journal of Economic Dynamics and Control in Eltville, Germany, the 1999 American Economic Association annual meetings, the 1999 Conference on Computing in Economics and Finance of the Society of Computational Economics, the Federal Reserve Board, and the Federal Reserve Bank of Kansas City. We received many constructive comments from Michael Binder, William Branch, Alex Cukierman, and Reinhard Tietz for which we are very grateful. Thanks also to Matthew Cardillo for excellent research assistance. The views expressed are those of the authors and do not necessarily represent those of the Federal Reserve Bank of Kansas City or the Federal Reserve Board.
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Related works:
Journal Article: Permanent and transitory policy shocks in an empirical macro model with asymmetric information (2005)
Journal Article: Permanent and transitory policy shocks in an empirical macro model with asymmetric information (2004)
Working Paper: Permanent and Transitory Policy Shocks in an Empirical Macro Model with Asymmetric Information (2004)
Working Paper: Permanent and transitory policy shocks in an empirical macro model with asymmetric information (2003)
Working Paper: Permanent and transitory policy shocks in an empirical macro model with asymmetric information (2003)
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