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Pitfalls of monetary policy under incomplete information: imprecise indicators and real indeterminacy

  • Eugenio Gaiotti

    ()

    (Banca d'Italia)

The paper examines the link between the precision of the available monetary policy indicators and the determinacy of equilibrium in a forward-looking macroeconomic model with partial information and an optimizing central bank. When the information on endogenous variables is not precise enough, the central bank acts too timidly; there is a possibility of self-fulfilling fluctuations in inflation and output. It is argued that, unless they are very precise, projections of output or inflation over the relevant horizon cannot be the only criterion for determining monetary policy actions. Rules which include a sufficient reaction to nominal variables may be necessary to supply an anchor for prices, even when the policymaker intends to consider all relevant information. Appointing a �conservative� central banker may also induce a less timid response to signs of inflation or deflation, even when their interpretation is difficult. In contrast, relying too much on measures of exogenous variables, such as potential output, can be counter-productive, because it could induce an attitude that is not responsive enough to inflation or deflation.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 488.

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Date of creation: Mar 2004
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Handle: RePEc:bdi:wptemi:td_488_04
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