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Managing Disinflation under Uncertainty

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Author Info
Mewael F. Tesfaselassie
Eric Schaling

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Abstract

In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases---certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP

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File URL: http://www.ifw-members.ifw-kiel.de/publications/disinflation-learning-and-optimal-monetary-policy/learninganddisinflation_KWPJune2008.pdf
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Publisher Info
Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1429.

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Length: 22 pages
Date of creation: Jun 2008
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Handle: RePEc:kie:kieliw:1429

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Related research
Keywords: Learning; Inflation Expectations; Disinflation Policy; Separation Principle; Kalman Filter; Optimal Control;

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Find related papers by JEL classification:
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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  1. Mewael F. Tesfaselassie, 2008. "Central Bank Learning and Monetary Policy," Kiel Working Papers 1444, Kiel Institute for the World Economy. [Downloadable!]
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