Inflation targeting with NAIRU uncertainty and endogenous policy credibility

Stochastic simulations are employed to compare performances of monetary pol icy rules in linear and nonlinear variants of a small macro model with NAIR U uncertainty under different assumptions about the way inflation expectati ons are formed. Cases in which policy credibility is ignored or treated as exogenous are distinguished from cases in which credibility and inflation e xpectations respond endogenously to the monetary authorities' track record in delivering low inflation. It is shown that endogenous policy credibility strengthens the case for forward-looking inflation forecast based rules re lative to backward-looking Taylor rules. (C) 2001 Elsevier Science B.V. All rights reserved. JEL classification: C51; E31; E52.