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Optimal Disinflation Under Learning

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  • Christian Matthes

    (Universitat Pompeu Fabra and Barcelona GSE)

  • Argia M. Sbordone

    (Federal Reserve Bank of New York)

  • Timothy Cogley

    (New York University)

Abstract

We model transitional dynamics that emerge after the adoption of a new monetary-policy rule. We assume that private agents learn about the new policy via Bayesian updating, and we study how learning affects the nature of the transition and choice of a new rule. The model endogenously generates time-varying volatility during the transition. Managing this volatility is the central bank's main challenge. The optimal policy depends on subtle features of the private sector's prior. Nevertheless, two robust conclusions emerge from our examples. First, the central bank can adjust target inflation freely without triggering high volatility. Second, none of our examples rationalizes a gradual reduction in inflation. On the contrary, inflation falls sharply at impact, overshoots the new target, and converges from below.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 74.

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Date of creation: 2011
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Handle: RePEc:red:sed011:74

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  1. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA.
  2. Elmar Mertens, 2010. "Managing beliefs about monetary policy under discretion," Finance and Economics Discussion Series 2010-11, Board of Governors of the Federal Reserve System (U.S.).
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  10. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
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  12. Timothy Cogley & Giorgio E. Primiceri & Thomas J. Sargent, 2008. "Inflation-Gap Persistence in the U.S," NBER Working Papers 13749, National Bureau of Economic Research, Inc.
  13. Ascari, Guido, 2002. "Staggered Price and Trend Inflation:Some Nuisances," Royal Economic Society Annual Conference 2002 10, Royal Economic Society.
  14. Tim W. Cogley & Thomas J. Sargent, 2005. "Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making," Working Papers 523, University of California, Davis, Department of Economics.
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  18. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
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