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Are Constant Interest Rate Forecasts Modest Policy Interventions? Evidence from a Dynamic Open‐Economy Model *
Author(s) -
Adolfson Malin,
Laséen Stefan,
Lindé Jesper,
Villani Mattias
Publication year - 2005
Publication title -
international finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 39
eISSN - 1468-2362
pISSN - 1367-0271
DOI - 10.1111/j.1468-2362.2005.00168.x
Subject(s) - economics , monetary policy , dynamic stochastic general equilibrium , interest rate , inflation (cosmology) , univariate , inflation targeting , psychological intervention , shock (circulatory) , constant (computer programming) , econometrics , macroeconomics , monetary economics , multivariate statistics , computer science , statistics , psychology , mathematics , medicine , physics , psychiatry , theoretical physics , programming language
This paper uses an estimated open‐economy dynamic stochastic general equilibrium model for the euro area to examine if during 1993Q4–2002Q4 constant interest rate forecasts (CIRFs), commonly used by inflation‐targeting central banks, are viewed as being in line with the central bank's historical policy behaviour. In the sense of Leeper and Zha (2003), a CIRF is defined as a modest intervention of the policy rule if it does not trigger the agents to revise their expectations about the inflation‐targeting policy. Using univariate modesty statistics, we show that the modesty of the policy interventions depends on the assumptions about the uncertainty in the future shock realizations. Taking the joint effects of the policy interventions on all variables into consideration, we find that the CIRFs are not modest policy interventions in the latter part of the sample (1998Q4–2002Q4), and thereby affect the expectations formation of the agents. Consequently, the constant interest rate assumption has arguably led to conditional forecasts at the two‐year horizon that cannot be considered economically meaningful during this period, and should not be used as a communication device by inflation‐targeting central banks.