Interest Rate Feedback Rules in an Open Economy with Forward Looking Inflation

With the adoption of an explicit inflation target in the UK, there has been renewed interest in the properties of alternative feedback rules for interest rates based on an inflation target. In this paper we compare the stabilisation properties of the two forms of feedback rule that have been used most frequently in the literature and in policy disculssion, Specifically, we examine the relative merits of relating excess inflation to the level of real interest rates, or the change in nominal interest arates in the face of various types of shock. We explain why the relative performance of the rules is dependent upon the nature of the shock considered and whether or not excess inflation is defined in terms of consumer or output price inflation.