Introduction
A considerable empirical literature has emerged on the estimation of policy reaction functions and the identification of the underlying preferences of monetary authorities (see Groeneveld, Koedijk and Kool, 1996; Muscatelli and Tirelli, 1996; Clarida and Gertler, 1997; Clarida, Galí and Gertner, 1998; Favero and Rovelli, 1999; and Muscatelli, Tirelli and Trecroci, 1999). Some of these contributions examine whether recent changes in institutional structure, such as the shift to inflation targeting, have had an impact on the conduct of monetary policy. The evidence is mixed. For instance, Muscatelli, Tirelli and Trecroci (1999) show that there is only slight evidence that the introduction of inflation targeting affected forward-looking policy reaction functions in the United Kingdom, New Zealand, Sweden and Canada. In contrast they find some evidence of policy instability in Japan and the United States in the 1980s and 1990s, even in the absence of institutional change.
Of course one would also expect significant shifts in monetary policy that bring about a reduction in inflation expectations to affect the transmission mechanism of monetary policy. The standard New Keynesian model of aggregate demand and supply, which has been used extensively for policy analysis (see Svensson, 1997; Rudebusch and Svensson, 1999; McCallum and Nelson, 1999a,b; and Rudebusch, 2000), suggests that forward-looking expectations are important on both the demand and the supply side.