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inflation, at least at any politically acceptable cost (Burns, 1979). A survey of six then-recent empirically estimated short-run Phillips curves by Okun (1978) sug-gested that the Federal Reserve would need to precipitate a 10 percent contraction of employment and output in the United States for one year for each permanent percentage point reduction of inflation that it wished to achieve. In other words, it appeared that it could take a modern Great Depression—a 10 percent contraction of output and employment sustained for almost 10 years—to achieve price stability. Even then, there was no guarantee that inflation would not begin to move higher again once restrictive monetary policy was relaxed. The arrival of Paul Volcker as chairman of the Federal Reserve in 1979 stands as a turning point. The Volcker Fed brought the inflation rate down to 4 percent by 1984, although it precipitated recessions in 1980 and 1981–82 to do so. Under Alan Greenspan, the Fed gradually worked the inflation rate down by the early 2000s below 2 percent, a range that Greenspan (2003) dubbed “effective price stability.” The improved inflationary picture in the United States was accompanied by parallel developments around the world. Average inflation worldwide declined from 14 percent in the early 1980s to 4 percent in the early 2000s (Rogoff, 2003).1 1 Rogoff (2003) reports that global inflation climbed in the first half of the 1990s and peaked at around 30 percent due to temporarily high inflation in the developing world, particularly, in transition economies.

The zero lower bound on nominal interest rates has constrained the Federal Reserve’s setting of the federal funds rate since December 2008. According to many macroeconomic models, this should have greatly reduced the effectiveness of monetary policy and increased the efficacy of fiscal policy. However, standard macroeconomic theory also implies that private-sector decisions depend on the entire path of expected future short-term interest rates, not just the current level of the overnight rate. Thus, interest rates with a year or more to maturity are arguably more relevant for the economy, and it is unclear to what extent the zero bound has constrained those yields. In this paper, we propose a novel approach to measure the effects of the zero lower bound on interest rates of any maturity. We compare the sensitivity of interest rates of various maturities to macroeconomic news during periods when short-term interest rates were very low to that during normal times. We find that yields on Treasury securities with a year or more to maturity were surprisingly responsive to news throughout 2008–10, suggesting that monetary and fiscal policy were likely to have been about as effective as usual during this period. Since mid-2011, the zero lower bound has been a greater constraint. We offer two explanations for these findings: First,

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. 1

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growing number of industrial and emerging economies have explicitly adopted an inflation target as their nominal anchor. Eight industrial countries and thirteen emerging economies had full-fledged inflation targeting in place in early 2005. Many other emerging economies are planning to adopt inflation targeting in the near future. This trend has triggered an intensifying debate over whether inflation targeting makes a difference. Opinions diverge widely over whether central banks are better off after they adopt inflation (forecast) targeting as an explicit and exclusive anchor for conducting monetary policy. Analysts are demanding hard evidence that inflation targeting improves macroeconomic performance relative to countries without explicit inflation targeting. Empirical evidence on the direct link between inflation targeting and particular measures of economic performance generally provides some support for the view that inflation targeting is associated with We thank Kevin Cowan for valuable discussion and methodological advice. Fabián

must be accountable for its actions, and its decisionmak-ing procedures should meet the highest standards of probity and technical competence. In light of the considerable discretion enjoyed by independent central banks, the standards of accountability that they must meet are per-haps even higher than for most other public institutions. Transparency allows for democratic scrutiny of the central bank and hence is an important pre-condition for central bank accountability. Few would question the proposi-tion that central banks must be transparent in this broad sense. A narrower debate over central bank transparency considers whether a central bank should publish its forecasts and whether it should have a publicly announced, numerical target for inflation. This narrower notion of transparency also impinges on issues of accountability and legitimacy, but the main focus in this debate has been on the effectiveness of monetary policy. Proponents of transparency in this narrower sense point to the impor-tance of the management of expectations in conducting monetary policy. A central bank generally controls directly only the overnight interest rate, “an interest rate that is relevant to virtually no economically interesting transactions, ” as Alan Blinder has put it.1 The links from this direct lever of monetary policy to the prices that matter, such as long-term interest 1

Abstract: We propose a new approach to test the full-information rational expectations hypothesis which can identify whether rejections of the null arise from information rigidities. This approach quantifies the economic significance of departures from the null and the underlying degree of information rigidity. Applying this approach to U.S. and international data of professional forecasters and other agents yields pervasive evidence consistent with the presence of information rigidities. These results therefore provide a set of stylized facts which can be used to calibrate imperfect information models. Finally, we document evidence of state-dependence in the expectations formation process.

Inflation targeting has been widely adopted in both developed and emerging economies. In this essay, I survey the evidence on the effects of inflation targeting on macroeconomic performance and assess what lessons this evidence provides for inflation targeting and the design of monetary policy. While macroeconomic experiences among both inflation targeting and non-targeting developed economies have been similar, inflation targeting has improved macroeconomic performance among developing economies. Importantly, inflation targeting has not been associated with greater real economic instability among either developed or developing economics. While cost shocks, such as the large rise in commodity prices that occurred in 2007 and early 2008, force central banks to make difficult short-run trade-offs, the ability to deal with demand shocks and financial crises can be enhanced by a commitment to an explicit target. This article was adapted from the John Kuszczak Memorial Lecture, prepared for the conference on ‘International Experience with the Conduct of Monetary Policy under Inflation Targeting’, held at the Bank of Canada, 22–23 July 2008. I would like to thank Mahir Binici for excellent research assistance and conference participants and an anonymous referee for comments and suggestions. Views expressed and remaining errors are my own.

This paper provides cross-country empirical evidence on bond risk premia. I construct a panel of zero-coupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and then use two different methods to decompose these forward rates into expected future short-term interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premium estimates declined across countries over the sample period, especially in countries that appear to have reduced inflation uncertainty by making substantial changes in the monetary policy frameworks of their central banks. During the recent financial crisis, term premiums have remained flat and even declined further in some countries, perhaps reflecting the effects of quantitative easing actions by many central banks.