In a paper presented at a recent conference at the Federal Reserve Bank of San Francisco, Kozicki and Tinsley (2003) develop an empirical model of the economy under the assumptions that the Fed’s implicit inflation target is subject to permanent shocks and that the public learns about the Fed’s target over time.
Although simple, their model allows for a much richer and realistic description of the evolution of monetary policy and the economy. For example, their approach gives empirical content to the idea of imperfect monetary policy credibility; in their model, monetary policy is credible when private expectations of long-run inflation tend to align closely with the central bank’s true underlying inflation target.