INFLATION-FORECASTS AND MONETARY-POLICY

Proposals for ''inflation targeting'' as a Strategy for monetary polic y leave open the important question of how to determine whether curren t policies are consistent with the long-run inflation target. An inter esting possibility is that the central bank might target current priva te-sector forecasts of inflation, either those made explicitly by prof essional forecasters or these implicit in asset prices. We address the issue of existence and uniqueness of rational expectations equilibria when the central bank uses private-sector forecasts as a guide to pol icy actions. In a dynamic model which incorporates both sluggish price adjustment and shocks to aggregate demand and aggregate supply, we sh ow that strict targeting of inflation forecasts is typically inconsist ent with the existence of rational expectations equilibrium, and that policies approximating strict inflation-forecast targeting are likely to have undesirable properties. We also show that economies with more general forecast-based policy rules are particularly susceptible to in determinacy of rational expectations equilibria. We conclude that, alt hough private-sector forecasts may contain information useful to the c entral bank, ultimately the monetary authorities must rely on an expli cit structural model of the economy to guide their policy decisions.