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Inflation contract, central bank transparency and model uncertainty

  • Dai, Meixing
  • Spyromitros, Eleftherios

Using a New-Keynesian model subject to misspecifications, we examine how the robust monetary policy could be modified by a linear inflation contract when a central bank is opaque about its preference for model robustness. It is shown that a central bank must limit this preference and opacity about it to ensure the dynamic stability of the economy. An optimal inflation contract with a zero penalty rate provides no incentive for a central bank to be opaque. The latter must rebalance the benefit of avoiding very bad outcomes in worst case scenarios and the economic costs due to higher macroeconomic volatility.

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Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 29 (2012)
Issue (Month): 6 ()
Pages: 2371-2381

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Handle: RePEc:eee:ecmode:v:29:y:2012:i:6:p:2371-2381
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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