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Endogenous monetary policy with unobserved potential output

Author

Listed:
  • Alex Cukierman

    (Tel-Aviv University)

  • Francesco Lippi

    (Banca d'Italia)

Abstract

This paper characterizes endogenous monetary policy when policymakers are uncertain about the extent to which movements in output and inflation are due to changes in potential output or to cyclical demand and cost shocks. We refer to this informational limitation as the �information problem� (IP). Main results of the paper are: 1. Policy is likely to be excessively loose (restrictive) for some time when there is a large decrease (increase) in potential output in comparison with a full information benchmark. 2. Errors in forecasting potential output and the output gap are generally serially correlated. These findings provide a partial explanation for the inflation of the seventies and the price stability of the nineties. 3. A quantitative assessment, based on an empirical model of the US economy developed by Rudebusch and Svensson (1999), indicates that during and following periods of large changes in potential output the IP significantly affects the dynamics of inflation and output. 4. The increase in the Fed�s conservativeness between the seventies and the nineties, and a more realistic appreciation of the uncertainties surrounding potential output in the second period, imply that the IP problem had a stronger impact in the seventies than in the nineties.

Suggested Citation

  • Alex Cukierman & Francesco Lippi, 2004. "Endogenous monetary policy with unobserved potential output," Temi di discussione (Economic working papers) 493, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_493_04
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    monetary policy; potential output; filtering; inflation; output gap;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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