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Managing Beliefs about Monetary Policy under Discretion?

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Optimal monetary policy becomes tricky when the central bank has better information than the public: Policy does not only affect economic fundamentals, but also people’s beliefs. For a general class of widely studied DSGE models, this paper derives the optimal discretionary policy under hidden information. Illustrated with a simple New Keynesian model, the introduction of hidden information has striking effects on discretionary policies: Policy losses are better under hidden information than under full transparency. Looking at Markov-perfect policies excludes reputational mechanisms via history dependent strategies. Under full transparency, discretion policies are then myopic, since a current policymaker cannot influence future decisions. But imperfect information adds public beliefs as a distinct, endogenous state variable. Managing beliefs connects the actions of policymakers such that they realize the inflationary consequences of expansionary policies. The optimal policy shares similarities with those from commitment models. Additionally, disinflations are pursued more vigorously the larger the credibility problems from hidden information. Optimal policy also responds to belief shocks, which shift public perceptions about fundamentals even when those fundamentals are unchanged.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 08.02.

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Length: 75 pages
Date of creation: Nov 2008
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Handle: RePEc:szg:worpap:0802

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Cited by:
  1. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  2. Cogley, Timothy & Matthes, Christian & Sbordone, Argia M., 2014. "Optimized Taylor Rules for Disinflation When Agents are Learning," Working Paper 14-7, Federal Reserve Bank of Richmond.
  3. Yang Lu & Ernesto Pasten & Robert King, 2013. "Policy design with private sector skepticism in the textbook New Keynesian model," 2013 Meeting Papers 241, Society for Economic Dynamics.
  4. Nunes, Ricardo, 2008. "Delegation and Loose Commitment," MPRA Paper 11555, University Library of Munich, Germany.
  5. Yang K. Lu & Ernesto Pasten & Robert G. King, 2008. "Managing expectations," 2008 Meeting Papers 959, Society for Economic Dynamics.
  6. Elmar Mertens, 2010. "Discreet Commitments and Discretion of Policymakers with Private Information," 2010 Meeting Papers 763, Society for Economic Dynamics.

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