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Monetary policy and inflationary shocks under imperfect credibility

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  • Darracq Pariès, Matthieu
  • Moyen, Stéphane

Abstract

In this note, we quantify the deterioration of achievable stabilization outcomes when monetary policy operates under imperfect credibility and weak anchoring of long-term expectations. Within a medium-scale Dynamic Stochastic General Equilibrium (DSGE) model, we introduce, through a simple signal extraction problem, an imperfect knowledge configuration in which price and wage setters wrongly have doubts about the determination of the central bank to maintain a fixed long-term inflation objective in the face of inflationary shocks. The magnitude of private sector learning has been calibrated to match the volatility of US inflation expectations at long horizons. We find that the costs of maintaining a given inflation volatility under weak credibility could amount to 0.25 percentage point (pp) of output gap standard deviation.

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Bibliographic Info

Article provided by Elsevier in its journal Economics Letters.

Volume (Year): 116 (2012)
Issue (Month): 3 ()
Pages: 571-574

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Handle: RePEc:eee:ecolet:v:116:y:2012:i:3:p:571-574

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Web page: http://www.elsevier.com/locate/ecolet

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Keywords: Monetary policy; Imperfect credibility; Signal extraction;

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References

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  1. Christopher J. Erceg and Andrew T. Levin, 2001. "Imperfect Credibility and Inflation Persistence," Computing in Economics and Finance 2001, Society for Computational Economics 19, Society for Computational Economics.
  2. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6112, C.E.P.R. Discussion Papers.
  3. Benati, Luca, 2008. "Investigating inflation persistence across monetary regimes," Working Paper Series, European Central Bank 0851, European Central Bank.
  4. Beechey, Meredith J & Johannsen, Benjamin K & Levin, Andrew, 2007. "Are Long-Run Inflation Expectations Anchored More Firmly in the Euro Area than in the United States?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6536, C.E.P.R. Discussion Papers.
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Cited by:
  1. Avadanei, Andreea, 2011. "Implicații ale politicii monetare unice în susținerea integrării financiare europene
    [The implications of single monetary policy in sustaining European financial integration]
    ," MPRA Paper 29147, University Library of Munich, Germany.
  2. Krause, Michael U. & Moyen, Stéphane, 2013. "Public debt and changing inflation targets," Discussion Papers 06/2013, Deutsche Bundesbank, Research Centre.

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