{
  "title": "Capacity Constraints, Inflation and the Transmission Mechanism: Forward-Looking Versus Myopic Policy Rules",
  "publication": "IMF Working Papers, August 1, 1995",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/30/capacity-constraints-inflation-and-the-transmission-mechanism-forward-looking-versus-myopic-1271",
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  "summary": "This paper develops a small model of the output-inflation process in the United States in order to examine the implications of alternative monetary policy rules.",
  "sections": [
    {
      "heading": "Model and key features",
      "content": "- The paper develops a small model of the output-inflation process in the United States to examine the implications of alternative monetary policy rules.\n- Two types of policy rules are considered:\n  - Myopic rule: interest rates respond contemporaneously to output and inflation.\n  - Forward-looking rule: interest rates exploit information about the nature of the transmission mechanism.\n- Two key model features:\n  - Significant lags between interest rates and aggregate demand conditions.\n  - An asymmetric model of inflation where positive deviations of aggregate demand from potential are more inflationary than negative deviations are disinflationary."
    },
    {
      "heading": "Main findings and analysis",
      "content": "- Asymmetry implication:\n  - Because positive demand deviations are more inflationary than negative deviations are disinflationary, allowing periodic overheating has asymmetric costs.\n- Consequences of a myopic policy rule:\n  - A policymaker following a myopic rule who allows the economy to overheat periodically will be forced to impose large recessions to keep inflation under control.\n  - The estimated degree of asymmetry implies that myopic policies can result in significant permanent losses in output.\n- Consequences of a forward-looking policy rule:\n  - Policymakers that follow a forward-looking rule and avoid overheating will reduce the variance of output.\n  - Such forward-looking policies will also raise the mean level of output."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Monetary policy should account for significant lags in the transmission mechanism to avoid delayed, large contractions.\n- Given the asymmetry in inflation responses to positive versus negative output gaps, policymakers should prioritize forward-looking reaction functions that prevent overheating rather than respond myopically to contemporaneous data.\n- Forward-looking policy rules can achieve both lower output volatility and higher average output compared with myopic rules."
    },
    {
      "heading": "Subjects and keywords (as listed)",
      "content": "- Subject: Capacity utilization, Financial services, Inflation, Output gap, Potential output, Prices, Production, Real interest rates\n- Keywords: aggregate demand, Capacity utilization, demand shock, Global, high-inflation period, Inflation, inflation expectation, inflation pressure, monetary policy, Output gap, output-inflation process, Phillips curve, Potential output, reaction function, Real interest rates, WP\n\nSource: Capacity Constraints, Inflation and the Transmission Mechanism: Forward-Looking Versus Myopic Policy Rules (IMF Working Papers), authors Peter B. Clark, Douglas Laxton, David Rose, August 1, 1995.\n\n---\n\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/30/capacity-constraints-inflation-and-the-transmission-mechanism-forward-looking-versus-myopic-1271"
    }
  ],
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    "Authors: Peter B. Clark, Douglas Laxton, David Rose",
    "Published: August 1, 1995",
    "Series: IMF Working Papers",
    "The paper develops a small model of the output-inflation process in the United States to examine the implications of alternative monetary policy rules.",
    "Two types of policy rules are considered:",
    "Two key model features:",
    "Asymmetry implication:",
    "Consequences of a myopic policy rule:",
    "Consequences of a forward-looking policy rule:",
    "Monetary policy should account for significant lags in the transmission mechanism to avoid delayed, large contractions.",
    "Given the asymmetry in inflation responses to positive versus negative output gaps, policymakers should prioritize forward-looking reaction functions that prevent overheating rather than respond myopically to contemporaneous data.",
    "Forward-looking policy rules can achieve both lower output volatility and higher average output compared with myopic rules.",
    "Subject: Capacity utilization, Financial services, Inflation, Output gap, Potential output, Prices, Production, Real interest rates",
    "Keywords: aggregate demand, Capacity utilization, demand shock, Global, high-inflation period, Inflation, inflation expectation, inflation pressure, monetary policy, Output gap, output-inflation process, Phillips curve, Potential output, reaction function, Real interest rates, WP"
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