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Central Bank Learning and Monetary Policy

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  • Mewael F. Tesfaselassie

Abstract

We analyze optimal monetary policy when a central bank has to learn about an unknown coefficient that determines the effect of surprise inflation on aggregate demand. We derive the optimal policy under active learning and compare it to two limiting cases---certainty equivalence policy and cautionary policy, in which learning takes place passively. Our novel result is that the two passive learning policies represent an upper and lower bound for the active learning policy, irrespective of the state of the economy

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1444.

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Length: 10 pages
Date of creation: Aug 2008
Date of revision:
Handle: RePEc:kie:kieliw:1444

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Keywords: parameter uncertainty; learning; monetary policy;

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References

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  1. Bertocchi, Graziella & Spagat, Michael, 1991. "Learning, Experimentation and Monetary Policy," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1991018, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  2. Mewael F. Tesfaselassie & Eric Schaling, 2009. "Managing Disinflation under Uncertainty," Working Papers 145, Economic Research Southern Africa.
  3. Timothy Cogley & Thomas Sargent & Riccardo Colacito, 2005. "Benefits from U.S. Monetary Policy Experimentation in the Days of Samuelson," 2005 Meeting Papers 791, Society for Economic Dynamics.
  4. Schaling, Eric, 2003. "Learning, inflation expectations and optimal monetary policy," Research Discussion Papers 20/2003, Bank of Finland.
  5. Noah Williams & Lars E.O. Svensson, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," 2007 Meeting Papers 446, Society for Economic Dynamics.
  6. Ellison, Martin, 2003. "The Learning Cost of Interest Rate Reversals," CEPR Discussion Papers 4135, C.E.P.R. Discussion Papers.
  7. Mervyn King, 1996. "How should central banks reduce inflation? - Conceptual issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 25-52.
  8. Kiefer, Nicholas M & Nyarko, Yaw, 1989. "Optimal Control of an Unknown Linear Process with Learning," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 571-86, August.
  9. Timothy Cogley & Riccardo Colacito & Thomas J. Sargent, 2005. "Benefits from U.S. monetary policy experimentation in the days of Samuelson and Solow and Lucas," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  10. Ellison, Martin & Valla, Natacha, 2000. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Working Paper Series 0028, European Central Bank.
  11. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Finance and Economics Discussion Series 2002-27, Board of Governors of the Federal Reserve System (U.S.).
  12. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
  13. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  14. Antulio N. Bomfim & Glenn D. Rudebusch, 1998. "Opportunistic and deliberate disinflation under imperfect credibility," Finance and Economics Discussion Series 1998-01, Board of Governors of the Federal Reserve System (U.S.).
  15. Balvers, Ronald J & Cosimano, Thomas F, 1994. "Inflation Variability and Gradualist Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 61(4), pages 721-38, October.
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