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Structural uncertainty and central bank conservatism: the ignorant should keep their eyes shut

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  • Michael Spagat
  • Joao Mauricio Rosal

Abstract

We study the problem of a central bank whose policy actions simultaneously affect the information flow about its expectations-augmented Phillips curve and its reputation for toughness in fighting inflation. In an environment with an unknown relationship between inflation surprises and output, big inflation surprises yield big short-term output gains and a strong information flow. Yet optimal policy is very conservative because inflation surprises yield information that increases the volatility of both future inflationary expectations and inflation itself. In fact, the more there is that can be learned about the Phillips curve the less does optimal policy aim towards learning.

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Bibliographic Info

Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2003 with number 93.

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Date of creation: 27 Sep 2004
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Handle: RePEc:mmf:mmfc03:93

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Web page: http://www.essex.ac.uk/afm/mmf/index.html

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  1. Robert J. Barro, 1986. "Reputation in a Model of Monetary Policy with Incomplete Information," NBER Working Papers 1794, National Bureau of Economic Research, Inc.
  2. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers, Bank of Finland 3/2002, Bank of Finland.
  3. Henrik Jensen, . "Optimal Degrees of Tranaparency in Monetary Policymaking," EPRU Working Paper Series, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics 01-01, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  4. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262522608, December.
  5. Prescott, Edward C, 1972. "The Multi-Period Control Problem Under Uncertainty," Econometrica, Econometric Society, Econometric Society, vol. 40(6), pages 1043-58, November.
  6. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, American Economic Association, vol. 75(3), pages 530-38, June.
  7. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  8. Hans Gersbach, 2003. "On the negative social value of central banks' knowledge transparency," Economics of Governance, Springer, Springer, vol. 4(2), pages 91-102, 08.
  9. Bertocchi, Graziella & Spagat, Michael, 1993. "Learning, experimentation, and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 32(1), pages 169-183, August.
  10. Wieland, Volker, 1999. "Monetary policy, parameter uncertainty and optimal learning," ZEI Working Papers B 09-1999, ZEI - Center for European Integration Studies, University of Bonn.
  11. Caplin, Andrew & Leahy, John, 1996. "Monetary Policy as a Process of Search," American Economic Review, American Economic Association, American Economic Association, vol. 86(4), pages 689-702, September.
  12. Grossman, Sanford J & Kihlstrom, Richard E & Mirman, Leonard J, 1977. "A Bayesian Approach to the Production of Information and Learning by Doing," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 44(3), pages 533-47, October.
  13. Balvers, Ronald J & Cosimano, Thomas F, 1994. "Inflation Variability and Gradualist Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(4), pages 721-38, October.
  14. Ellison, Martin & Valla, Natacha, 2000. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Working Paper Series, European Central Bank 0028, European Central Bank.
  15. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
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Cited by:
  1. Ellison, Martin, 2006. "The learning cost of interest rate reversals," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(8), pages 1895-1907, November.
  2. Miller, Marcus & Thampanishvong, Kannika & Zhang, Lei, 2003. "Learning to Forget? Contagion and Political Risk in Brazil," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3785, C.E.P.R. Discussion Papers.

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