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LEARNING AND THE EVOLUTION OF THE FED’S INFLATION TARGET

Published online by Cambridge University Press:  20 May 2019

Fabio Milani
Fabio Milani*
Affiliation:
University of California
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Abstract

This paper tries to infer and compare the evolution of the Federal Reserve’s (unobserved) inflation target series by estimating a monetary model under the alternative assumptions of rational expectations or subjective expectations and learning. In the estimated model that assumes that economic agents have rational expectations, the implied inflation target displays large shifts over time: it starts at 2% in the early 1960s, it rises to 8% in the 1970s, and it falls to 4% and 2% in the 1980s and 1990s. When the assumption of rational expectations is relaxed in favor of learning by the policymaker, the inferred target is, instead, remarkably stable over time. The target assumes values between 2% and 3% over the whole postwar sample. The findings suggest changing beliefs and learning by the Federal Reserve as major endogenous causes of the perceived variation in the inflation target. When the model is allowed to take the central bank’s evolving beliefs into account, the joint evolution of US inflation, output, and monetary policy decisions can be explained without requiring large exogenous changes in the inflation target.

Keywords

Time-Varying Inflation TargetLearningExpectationsBayesian Estimation
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 8 , December 2020 , pp. 1904 - 1923
Copyright
© 2019 Cambridge University Press

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Footnotes

A previous version of this paper was titled “The Evolution of the Fed’s Inflation Target in an Estimated Model under RE and Learning”. I would like to thank the Editor, Associate Editor, and two anonymous referees for comments and suggestions.

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