MONETARY POLICY RULES UNDER HETEROGENEOUS INFLATION EXPECTATIONS

This paper evaluates the role of inflation-forecast heterogeneity in U.S. monetary policymaking. The deviation between private and central bank inflation forecasts is identified as a significant explanatory factor behind the Fed's monetary policy decisions. A discretionary policy rule that includes the forecast deviation as an additional argument is estimated empirically for the period 1975-2009, covering the chairmanships of Arthur Burns, George Miller, Paul Volcker, Alan Greenspan, and the beginning of Ben Bernanke's term, by using inflation forecasts obtained from the Federal Open Market Committee's Greenbook and the Survey of Professional Forecasters and real-time estimates of the output gap. The estimated rule appears to provide a consistent description of the Fed's policy during the sample period presenting an alternative perspective regarding the key drivers of the high-inflation phase in the 1970s as well as of the successful Volcker disinflation in the early 1980s and the gradual transition to a regime of lower inflation and high policy credibility that has increasingly characterized monetary policy over the past two decades. (JELE50, E52, E58)