XML

Seoul Journal of Economics - Vol. 20 , No. 2
[Paper List] [Go to Volume List]

[ Article ]
Seoul Journal of Economics - Vol. 20, No. 2, pp. 239-262
Abbreviation: SJE
ISSN: 1225-0279 (Print)
Print publication date 31 May 2007
Received 26 Dec 2006 Revised 19 Apr 2007

Rational Expectations, Long-run Taylor Rule, and Forecasting Inflation
Byeongseon Seo ; Sokwon Kim
Associate Professor, Department of Economics, Soongsil University, Seoul 156-743, Tel: +82-2-820-0552, Fax: +82-2-824-4384 (seo@ssu.ac.kr)
Research Fellow, Monetary Policy Committee Office, Bank of Korea, Seoul 100-794, Tel: +82-2-759-4790, Fax: +82-2-750-6749 (kimsw@bok.or.kr)

Funding Information ▼

JEL Classification: E37, E43

Abstract

The rational expectations model implies that nominal interest rates reflect expectations of inflation, and thus the term structure of interest rates provides information on the future change in inflation. However, the monetary authority manipulates the short-term interest rate in response to the change in the price level, and accordingly the prediction of inflation cannot be separated from the monetary policy. This paper explores the linkage between the monetary policy rules and the prediction of inflation. The prediction of inflation can be influenced by the monetary policy rules if the Fed reacts strongly to inflation. Using the long-run Taylor rule, an assessment of the prediction performance regarding future change in inflation is provided. The empirical results indicate that the long-run Taylor rule improves forecasting accuracy.

Keywords: Fisher equation, Monetary policy rules, Predictability
Acknowledgments

The authors thank Dennis Jansen, Hyuneuy Kim, Jin Kim, Myungjik Kim, Daniel Leigh, Glenn Rudebusch, Mark Wohar, and the seminar participants at the BOK/KAEA Conference and the 2005 WEA Conference for useful comments and suggestions. Special thanks are owed to anonymous referees for invaluable comments and suggestions. The views expressed are those of the authors and do not necessarily reflect the official views of the Bank of Korea. Seo thanks Soongsil University for research support.

References
1. Andrews, D. “Tests for Parameter Instability and Structural Change with Unknown Change Point.” Econometrica 61 (No. 4 1993): 821-56.
2. Atkeson, A., and Ohanian, L. “Are Phillips Curves Useful for Forecasting Inflation?” Federal Reserve Bank of Minneapolis, Quarterly Review 25 (Winter 2001): 2-11.
3. Balduzzi, P., Bertola, G., and Foresi, S. “A Model of Target Changes and the Term Structure of Interest Rates.” Journal of Monetary Economics 39 (No. 2 1997): 223-49.
4. Clarida, R., Gali, J., and Gertler, M. “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory.” Quarterly Journal of Economics 115 (No. 1 2000): 147-80.
5. Engle, R., and Granger, C. “Co-integration and Error Correction: Representation, Estimation, and Testing.” Econometrica 55 (No. 2 1987): 251-76.
6. Estrella, A., and Hardouvelis, G. “The Term Structure as a Predictor of Real Economic Activity.” Journal of Finance 46 (No. 2 1991): 555-76.
7. Fama, E. “Term-Structure Forecasts of Interest Rates, Inflation, and Real Returns.” Journal of Monetary Economics 25 (No. 1 1990): 59-76.
8. Fisher, I. The Theory of Interest. New York: Macmillan, 1930.
9. Johansen, S. “Statistical Analysis of Cointegration Vectors.” Journal of Economic Dynamics and Control 12 (Nos. 2-3 1988): 231-54.
10. Judd, J., and Rudebusch, G. “Taylor's Rule and the Fed: 1970-1997.” Federal Reserve Bank of San Francisco, Economic Review (No. 3 1998): 3-16.
11. Mankiw, G., and Miron, J. “The Changing Behavior of the Term Structure of Interest Rates.” Quarterly Journal of Economics 101 (No. 2 1986): 211-28.
12. Mishkin, F. S. “What Does the Term Structure Tell Us about Future Inflation?” Journal of Monetary Economics 25 (No. 1 1990): 77-95.
13. Mishkin, F. S. “A Multi-Country Study of the Information in the Shorter Maturity Term Structure about Future Inflation.” Journal of International Money and Finance 19 (No. 1 1991): 2-22.
14. Orphanides, A. “The Quest for Prosperity without Inflation.” Journal of Monetary Economics 50 (No. 3 2003): 633-63.
15. Rudebusch, G. “Federal Reserve Interest Rate Targeting, Rational Expectations, and the Term Structure.” Journal of Monetary Economics 35 (No. 2 1995): 245-74.
16. Rudebusch, G. “Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia.” Journal of Monetary Economics 49 (No. 6 2002): 1161-87.
17. Ruge-Murcia, F. “Does the Barro-Gordon Model Explain the Behavior of Us Inflation? A Reexamination of Empirical Evidence.” Journal of Monetary Economics 50 (No. 6 2003): 1375-90.
18. Seo, B. “Tests for Structural Change in Cointegrated Systems.” Econometric Theory 14 (No. 2 1998): 222-59.
19. Seo, B. “Nonlinear Mean Reversion in the Term Structure of Interest Rates.” Journal of Economic Dynamics and Control 27 (Nos. 11-12 2003): 2243-65.
20. Stock, J. H., and Watson, M. W. “Forecasting Inflation.” Journal of Monetary Economics 44 (No. 2 1999): 293-335.
21. Taylor, J. “Discretion versus Policy Rules in Practice.” Carnegie-Rochester Conference Series on Public Policy 39 (1993): 195-214.
22. Woodford, M. Optimal Monetary Policy Inertia. NBER Working Paper, No. 7261, 1999.
 

Editorial Office, Seoul Journal of Economics, Institute of Economic Research, Seoul National University 599 Gwanangno, Gwanak-gu, Seoul 151-746, Korea
Tel: +82-2-880-5434 | Fax: +82-2-888-4454 | E-mail: sje@plaza.snu.ac.kr
Copyright (c) 2020 SJE. All rights reserved.