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‘Talking down monetary policy’ – a note

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  • Peter Tillmann

Abstract

There is a recent debate about whether ultra-expansionary monetary policy is no longer effective in stimulating demand, a concern often voiced in the euro area in light of persistently low and even negative inflation. As a response, the European Central Bank (ECB) warns against ‘talking down monetary policy’ (ECB Vice-President Vítor Constâncio, 2016). This note uses a textbook model of optimal monetary policy to study a situation in which the public misperceives the interest rate elasticity of aggregate demand, which reflects policy effectiveness. We show that as a result of underestimating policy effectiveness demand shocks can no longer be stabilized perfectly, thus resulting in inefficient inflation and output dynamics. In the presence of misperceptions, a negative demand shock leads to a prolonged period of negative inflation rates.

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  • Peter Tillmann, 2017. "‘Talking down monetary policy’ – a note," Applied Economics Letters, Taylor & Francis Journals, vol. 24(20), pages 1443-1447, November.
    • Handle: RePEc:taf:apeclt:v:24:y:2017:i:20:p:1443-1447
    DOI: 10.1080/13504851.2017.1282140
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