Inflation Targeting and Nonlinear Policy Rules: The Case of Asymmetric Preferences (new title: The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences)

CESifo Working Paper No. 1280

Inflation Targeting and Nonlinear Policy
Rules: The Case of Asymmetric Preferences

Abstract

This paper investigates the empirical relevance of a new framework for monetary policy
analysis in which the decision-makers are allowed to weight differently positive and negative
deviations of inflation and output from the target values. Reduced-form and structural
estimates of the central bank first order condition indicate that the preferences of the Fed have
been highly asymmetric only before 1979, with the response to output contractions being
larger than the response to output expansions of the same magnitude. This asymmetry is
shown to induce an average inflation bias of 1.11% that appears to have substantially
contributed to the great inflation of the 1960s and 1970s.

JEL Code: E52, E58.

Keywords: asymmetric objective, nonlinear monetary policy rules, average inflation bias.

Paolo Surico

Istituto di Economia Politica

Università Bocconi
Via Gobbi 5
20136 Milan
Italy
[email protected]

I wish to thank Efrem Castelnuovo, Carlo Favero, Jordi GaH, Tommaso Monacelli, Anton
Muscatelli, Giorgio Primiceri, Stephan Sauer, Ulf Soderstrom, Guido Tabellini and Jonathan
Temple for very useful comments. I am also grateful to seminar participants at the Bank of
England, Bocconi University, European Central Bank, Goethe University of Frankfurt and
Sverige Riksbank as well as conference participants at the Annual Meetings of the Royal
Economic Society 2003, Society for Computational Economics 2004 and CesIfo Venice
Summer Institute 2004.

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