Efficient policy rule for inflation targeting in Colombia

Abstract

In a small macroeconomic model of the Colombian economy I investigate the problem of selecting an efficient simple policy rule - rules that exploit a reduced information set-that is consistent with inflation targeting. Even though simple policy rules are not as efficient as the optimal state-contingent policy rules, in the literature it has been shown that some simple rules can approximate them very well. I spell out the characteristics of the feedback and output parameters in simple Taylor and Inflation-forecast rules, as well as the optimal forecasting horizon for inflation targeting. Using stochastic simulations of the model it is found that, as expected, simple rules that use forecasts of inflation rather than just contemporaneous inflation have better stabilization properties.