1 Introduction
Many models that are used to evaluate monetary policy assume, either explicitly or
implicitly, that (1) the inflation target of monetary policy is constant over the period
being analyzed; and, (2) the inflation target is known by all economic agents. Because
the actual and perceived inflation targets are equal and fixed, long-horizon expectations
are independent of short-run policy in such models.1 Consequently, all monetary policy
actions are transient, and monetary policy appears to contribute only modestly to postwar
fluctuations in bond rates and economic activity.
The assumption that the inflation target is fully credible is surprisingly prevalent in
recent studies that examine historical policy or evaluate alternative policies. The literature
that evaluates policy alternatives under a constant and credible inflation target is vast.
Optimizing models used to evaluate alternative monetary policies, such as those reviewed in
Taylor (1999), generally assume a constant inflation target is common knowledge. Likewise,
standard atheoretical empirical analyses of policy effects implicitly assume a fixed policy
target or stationary nominal anchor. As noted by Kozicki and Tinsley (2001a), VARs
containing the levels of inflation and nominal interest rates imply constant and known
natural rates for those variables.
The traditional assumption that policy ob jectives were known to the private sector
was accompanied in early studies by an emphasis on the real effects of unanticipated
changes in monetary policy, such as Lucas (1973) and Sargent and Wallace (1976). Because
imperfectly observed policy is equivalent to unanticipated policy, several early studies
noted that monetary policy could have larger real effects in learning or filtering transitions
between persistent shifts in policy, such as Taylor (1980), Meyer and Webster (1982), and
1 The conclusion that long-run expectations are independent of short-run policy presumes that the policy
being followed is consistent with the goals of policy. For example, a Taylor-type (1993) interest rate rule
with an explicit numerical inflation target that doesnt satisfy the Taylor principle would generally lead to
explosive inflation and explosive private-sector inflation forecasts. Such a policy rule would be inconsistent
with the inflation target.