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Probing Potential Output: Monetary Policy, Credibility, and Optimal Learning under Uncertainty

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  • Yetman, James

Abstract

The effective conduct of monetary policy is complicated by uncertainty about the level of potential output, and thus about the size of the monetary policy response that would be sufficient to achieve the targeted inflation rate. One possible response to such uncertainty is for the monetary authority to "probe," interpreted here as actively using its policy response to learn about the level of potential output. Monetary authorities have put significant emphasis in recent years on attaining credibility for their policy objectives. These steps have anchored inflation expectations to the target of the monetary authority more firmly. I consider a simple calibrated model in the Canadian context and examine the relationship between credibility and optimal probing. I find that, for plausible parameter values, the optimal amount of probing is small and varies little with credibility. Only for low levels of credibility or unrealistically large levels of uncertainty or volatility does the optimal policy with probing diverge significantly from a policy that ignores learning. Even then, the optimal amount of probing diminishes as credibility rises.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 00-10.

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Length: 37 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:bca:bocawp:00-10

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Keywords: Credibility; Potential output; Uncertainty and monetary policy;

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References

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  8. Arturo Estrella & Frederic S. Mishkin, 1999. "Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 405-436 National Bureau of Economic Research, Inc.
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Cited by:
  1. Doyle, Matthew, 2006. "On the Optimality of Delay in 'Monetary Policy As a Process of Search'," Staff General Research Papers 12503, Iowa State University, Department of Economics.
  2. Tesfaselassie, M.F. & Schaling, E. & Eijffinger, S.C.W., 2006. "Learning About the Term Structure and Optimal Rules for Inflation Targeting," ERIM Report Series Research in Management ERS-2006-058-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
  3. Jean-Philippe Cayen & Simon van Norden, 2002. "La fiabilité des estimations de l'écart de production au Canada," Working Papers 02-10, Bank of Canada.
  4. Mewael F. Tesfaselassie & Eric Schaling, 2009. "Managing Disinflation under Uncertainty," Working Papers 145, Economic Research Southern Africa.
  5. Gilbert Bougi & Helmi Hamdi, 2007. "La crédibilité de la banque centrale face aux défis de la monnaie électronique," CAE Working Papers 56, Aix-Marseille Université, CERGAM.
  6. In Chang Hwang & Richard S.J. Tol & Marjan W. Hofkes, 2013. "Active Learning about Climate Change," Working Paper Series 6513, Department of Economics, University of Sussex.

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