SFB 303 Discussion Paper No. B-161

Author: Schmidt, Roland
Title: Inflation Expectations if the Target Rate of the Central Bank is Uncertain
Abstract: This paper shows how inflation expectations have to be formed if the monetary regime shifts with some probability. The inflation target of the central bank is described by a Markov process and individuals use actual inflation rates to conjecture about the target rates. As it turns out, expectations follow a distributed lag model. In the empirical part this expectation model is estimated within the Fisher equation and the theoretical restrictions are tested. We find that the inflation volatility was not caused by target rate shifts of the Deutsche Bundesbank but mainly by control errors and other nonsystematic disturbances. The high autocorrelation of inflation rates has to be attributed to a steady monetary policy and is not due to price stickiness.
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Creation-Date: September 1990
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