Monetary Policy, Nominal Interest Rates, and Long-Horizon Inflation Uncertainty
University of Cambridge DAE Working Paper No. 9820
44 Pages Posted: 27 Dec 1998
Date Written: October 1998
Empirical evidence presented in this paper shows that the predictability of inflation at long horizons varies considerably across countries. Both simple theory and empirical evidence suggest that the crucial factor is the extent to which systematic monetary policy succeeds in stabilizing the incipient unit root in inflation. The mechanism by which it does this appears however to be complicated by strong empirical evidence that nominal interest rates have real effects, which implies that monetary policy need not be so vigorous in reactions to inflation. This helps to explain why inflation rates in the U.S. and (especially) Germany have been relatively predictable, despite monetary policy rules which appear to have been barely stabilizing. The paper also presents tentative evidence that the power of nominal interest rate effects is inversely related to long-horizon inflation uncertainty, and hence ultimately uncertainty about monetary policy.
JEL Classification: C32, E31, E50, E52
Suggested Citation: Suggested Citation