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Reviewing US Monetary Policy in Disinflation Era: A Primer *1

September 2004
Ryo Kato *2
Yoko Takeda *3

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  • *1 We thank Karen Johnson, Dale Henderson, Athanosios Orphanides, David Small, Harry Toyama, Hiroshi Ugai, Tatsushi Kurihara, Shigenori Shiratsuka, Hiroshi Fujiki, Ippei Fujiwara, Naohiko Baba and the seminar participants at the Board of Governors for helpful comments and discussions. We are especially grateful to Shin-Ichi Nishiyama and Naoko Hara for their invaluable assistance in numerical simulations. Remaining errors are our own. The views presented in this paper are solely those of the authors and not those of the Bank of Japan.
  • *2 Corresponding author: 2-1-1 Nihonbashi-Hongokucho, Chuo-ku, Tokyo, 103-8660, JAPAN.
  • *3 Formerly of the International Deparment, Bank of Japan.


This paper reviews the experience of US monetary policy from 2000 to shed some light on issues regarding the effectiveness of monetary policy in a low inflation era. Our analysis is twofold. First, based on a simple inflation forecast targeting model introduced in Svensson (1997) and Kato and Nishiyama (2002) as its variant, we demonstrate that the actual federal funds rate closely followed its optimal path predicted by the model from the late 90s to mid-2003. Second, we examine the response of long-term interest rates or an implied forward curve to FOMC's policy changes by employing a version of the new IS/LM model. The result shows that the observed financial market response to the FOMC's statement released in August 2003 can be no less consistent with an effective change in the expectation of the degree of interest rate inertia than a failed policy commitment. Our simulation suggests that we cannot conclude that the Fed's commitment was ineffective during the recent phase of stagnation.

JEL Classification:
E5, E4, C6