Economic Quarterly

Recent research has emphasized that the Federal Reserve under Chairman Alan Greenspan was forward looking, smoothed interest rates, and focused on core inflation. The semiannual monetary policy reports to U.S. Congress indicate that the measure of inflation used in monetary policy deliberations has also been refined over time: For most of the Greenspan period before 2000, inflation forecasts used the consumer price index (CPI), but in the early 2000s, inflation forecasts switched to using the core personal consumption expenditures (PCE) deflator. Using information contained in Greenbook forecasts, this article estimates two forward-looking Taylor rules that differ only with respect to the measure of inflation used over 1987:1-2006:4. A Taylor rule that is estimated using a time-varying measure of core inflation-CPI until 2000 and PCE thereafter-depicts parameter stability in the Greenspan years, and tracks the actual path of the federal funds rate during the subperiod 2000:1–2006:4, when the measure of inflation used changed. In contrast, a Taylor rule that is estimated using headline CPI inflation does not depict such parameter stability, and indicates the actual funds rate was too low relative to the level prescribed during the subperiod 2000:1-2006:4, as headline CPI inflation remained elevated because of the continual rise in oil prices. Moreover, in real time during most of this subperiod, core PCE inflation was much lower than what is indicated by the current vintage data. These results highlight the importance of using real-time information in evaluating historical monetary policy actions.