Title

Is the future really observable? A practical approach to model monetary policy rules

Document Type

Article

Publication Date

9-1-2021

Abstract

We take a practical approach to model the forward-looking monetary policy rule. Unlike existing studies, we recognize that the forward-looking components—future inflation and output growth—are intrinsically unobserved at the time policy formulation. Using the unobserved components framework, we extract the latent components of the policy rule from the short-term and long-term Greenbook forecasts, both individually and in combination, and jointly estimate the policy parameters. We also consider correlations between different components and combine the forecasts from the survey of professional forecasters and the inflation index bonds market. Evidence suggests that the Federal Reserve follows an inflation-tilted policy rule and the long-term state of economy gets a higher weight than the short term. Also, the policy reaction is more aggressive when interconnections between different components of the policy rule are considered.

DOI

10.1007/s00181-020-01910-7

Publication Title

Empirical Economics

Volume Number

61

Issue Number

3

First Page

1189

Last Page

1223

ISSN

03777332

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