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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 20, No. 2, pp.239-262
ISSN: 1225-0279 (Print)
Print publication date 31 May 2007
Received 26 Dec 2006 Revised 19 Apr 2007

Rational Expectations, Long-run Taylor Rule, and Forecasting Inflation

Byeongseon Seo ; Sokwon Kim
Associate Professor, Department of Economics, Soongsil University, Seoul 156-743, Tel: +82-2-820-0552, Fax: +82-2-824-4384 seo@ssu.ac.kr
Research Fellow, Monetary Policy Committee Office, Bank of Korea, Seoul 100-794, Tel: +82-2-759-4790, Fax: +82-2-750-6749 kimsw@bok.or.kr

JEL Classification: E37, E43

Abstract

The rational expectations model implies that nominal interest rates reflect expectations of inflation, and thus the term structure of interest rates provides information on the future change in inflation. However, the monetary authority manipulates the short-term interest rate in response to the change in the price level, and accordingly the prediction of inflation cannot be separated from the monetary policy. This paper explores the linkage between the monetary policy rules and the prediction of inflation. The prediction of inflation can be influenced by the monetary policy rules if the Fed reacts strongly to inflation. Using the long-run Taylor rule, an assessment of the prediction performance regarding future change in inflation is provided. The empirical results indicate that the long-run Taylor rule improves forecasting accuracy.

Keywords:

Fisher equation, Monetary policy rules, Predictability

Acknowledgments

The authors thank Dennis Jansen, Hyuneuy Kim, Jin Kim, Myungjik Kim, Daniel Leigh, Glenn Rudebusch, Mark Wohar, and the seminar participants at the BOK/KAEA Conference and the 2005 WEA Conference for useful comments and suggestions. Special thanks are owed to anonymous referees for invaluable comments and suggestions. The views expressed are those of the authors and do not necessarily reflect the official views of the Bank of Korea. Seo thanks Soongsil University for research support.

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