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School of Economics and Finance

No. 820: The Federal Reserve’s implicit inflation target and Macroeconomic dynamics. A SVAR analysis.

Haroon Mumtaz , Queen Mary University of London
Konstantinos Theodoridis , Lancaster University Management School and the Bank of England

April 17, 2017

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This paper identifies shocks to the Federal Reserve’s inflation target as VAR innovations that make the largest contribution to future movements in long-horizon inflation expectations. The effectiveness of this scheme is documented via Monte-Carlo experiments. The estimated impulse responses indicate that a positive shock to the target is associated with a large increase in inflation, GDP growth and long-term interest rates. Target shocks are estimated to be a vital factor behind the increase in inflation during the pre-1980 period and are an important driver of the decline in long-term interest rates over the last two decades.

J.E.L classification codes: C5, E1, E5, E6

Keywords:SVAR, DSGE model, inflation target