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Optimal discretionary policy and uncertainty about inflation persistence

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  • Moessner, Richhild
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    Abstract

    This paper studies optimal discretionary policy with parameter uncertainty about inflation inertia. Optimal policy rules and impulse responses are presented within a hybrid New-Keynesian model estimated for the euro area by Smets (2003). We find that it may be optimal for policy to respond more aggressively to cost-push shocks and real interest rate shocks in the presence of uncertainty about inflation inertia, depending on the form of the central bank’s objective function. Moreover, in the cases where optimal policy is not certainty equivalent, we find that inflation returns slightly more gradually to equilibrium following a shock when the degree of inflation inertia is uncertain. JEL Classification: E52, E58

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 0540.

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    Date of creation: Nov 2005
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    Handle: RePEc:ecb:ecbwps:20050540

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    Keywords: Inflation persistence; monetary policy; uncertainty;

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    1. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
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    Cited by:
    1. Leitemo , Kai & Söderström , Ulf, 2005. "Robust monetary policy in a small open economy," Research Discussion Papers 20/2005, Bank of Finland.
    2. Séverine Menguy, 2009. "Heterogeneity in Inflation Persistence and Monetary Policy in a Monetary Union," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 52(2), pages 121-141.
    3. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
    4. Siok Kun, Sek, 2009. "The impacts of economic structures on the performance of simple policy rules in a small open economy," MPRA Paper 25065, University Library of Munich, Germany.
    5. Miguel Casares, 2006. "A close look at model-dependent monetary policy design," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 451-470.

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