Can Ignorance Make Central Banks Behave?
AbstractThis paper presents a model in which "instrument uncertainty"-that is, an uncertain mapping from monetary policy to macroeconomic outcomes-may mitigate the inflationary bias problem that arises when efficient monetary policy rules are time- inconsistent. If the relation between monetary policy and macroeconomic outcomes is uncertain, the private sector has an incentive to scrutinize the past for clues about this relationship. This learning creates a link between past government behavior and present inflation expectations that the government can exploit to enhance its credibility. The model implies that the two conventional arguments for simple rules in monetary policy-one stressing the central bank's poor forecasting abilities and the other stressing the perils of discretion-may work at cross-purposes. Moreover, it provides an explanation of the cyclical behavior of inflation due to political cycles and of the correlation between the level and variance of inflation.
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Bibliographic InfoPaper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 291..
Length: 17 pages
Date of creation: Jul 1995
Date of revision:
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Postal: Boston College, 140 Commonwealth Avenue, Chestnut Hill MA 02467 USA
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More information through EDIRC
instrument uncertainty; monetary policy; inflationary bias; time- inconsistency; learning.;
Find related papers by JEL classification:
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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