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

Estimates of the perceived inflation target series are shown in Figure 3 with inflation
and long-term inflation expectations data from the Survey of Professional Forecasters.
Movements in the perceived target tend to lag inflation, but track survey data on long-term
inflation expectations quite well. The survey evidence provides independent support for
the timing of movements in the perceived inflation target. Some differences between the
perceived target series and the long-term inflation expectations series are to be expected.
The long-term inflation expectations series is from a survey of expectations of inflation
over the next 10 years while the perceived target is a limit of expectations. Also, the
inflation series and estimated perceived target series are for inflation rates based on the
chain price index for core personal consumption expenditures, while the long-term inflation
expectations series is for inflation rates based on the consumer price index.

A notable feature of the estimated perceived target series is that the perceived target
remains above inflation for much of the early- to mid-1980s and also in the 1990s. One
interpretation is that in October 1979, when the FOMC undertook a change in policy
to lower inflation, the private sector did not immediately see the new policy as fully
credible. The perceived inflation target and long-term interest rates remained elevated
despite declines in inflation in the early to mid 1980s. Only as policy was set to keep
inflation low, did the perceived inflation target gradually recede towards the actual inflation
rate.

The behavior of the estimated perceived inflation target in the 1980s may provide new
insight on a debate between empirical and theoretical macroeconomic research. Theoretical
macro models generally assume rational forward-looking behavior. By contrast, empirical
researchers often opt for backward-looking assumptions in order to explain empirical
regularities (Rudebusch (1998)). Comparing the estimated perceived target to inflation
suggests an alternative view. In particular, if movements in the perceived inflation target
lag movements in actual inflation, then rational forward-looking behavior on the part of

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