Permanent and Transitory Policy Shocks in an Empirical Macro Model with Asymmetric Information

of persistence of inflation deviations as well as persistence in movements of the perceived
inflation target. Thus, in small samples, estimates of persistence will tend to be close to the
persistence of inflation deviations during periods when fluctuations in the perceived inflation
target are small, such as 1986-1994, or 1997-2001. However, in periods with large movements
in the perceived inflation target, such as 1966-1982, estimates of inflation persistence will
be larger as they will be influenced by low frequency movements in the perceived inflation
target.

The estimated transition equation for the implicit target found significant evidence of
partial accommodation of supply shocks on the part of policymakers. The estimate of cST
implies that on average about 3/4 of each supply shock was accommodated by policy. It
should be noted that this estimate implies accommodation of adverse supply shocks such
as higher oil or import prices and negative productivity shocks that would tend to raise
inflation, as well as of supply shocks that would tend to lower inflation.

As expected, coefficient estimates of the Volker regime change parameter η are negative
and imply that the implicit target was reduced by 4.5 percentage points between 1979Q4
and 1982Q4. The coefficient estimate is insignificant, but based on only a few observations.
The variance of exogenous permanent target shocks and the variance of expectations shocks
were constrained to be equal. In the absence of this restriction, the standard errors of these
parameter estimates were large. The restricted estimates imply that exogenous target shocks
and exogenous expectations shocks tend to be relative small, with a standard deviation of
σ_T = σ_P = 0.21.

The estimated learning parameter, δ, is significant and implies that 8 percent of policy
forecast errors are mapped into perceived target shifts. With an estimated policy response
to inflation of 0.53, roughly 4 percent of the gap between the target and perceived target
is closed each quarter. This relatively slow learning rate implies lengthy lags between
movements of the inflation target and the perceived target.

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