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Optimal discretionary policy and uncertainty about inflation persistence

  • Moessner, Richhild
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    This paper studies optimal discretionary policy with parameter uncertainty about inflation inertia. Optimal policy rules and impulse responses are presented within a hybrid New-Keynesian model estimated for the euro area by Smets (2003). We find that it may be optimal for policy to respond more aggressively to cost-push shocks and real interest rate shocks in the presence of uncertainty about inflation inertia, depending on the form of the central bank’s objective function. Moreover, in the cases where optimal policy is not certainty equivalent, we find that inflation returns slightly more gradually to equilibrium following a shock when the degree of inflation inertia is uncertain. JEL Classification: E52, E58

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    Paper provided by European Central Bank in its series Working Paper Series with number 0540.

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    Date of creation: Nov 2005
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    Handle: RePEc:ecb:ecbwps:20050540
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    1. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
    2. Alexei Onatski & Noah Williams, 2003. "Modeling Model Uncertainty," NBER Working Papers 9566, National Bureau of Economic Research, Inc.
    3. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
    4. Kimura, Takeshi & Kurozumi, Takushi, 2007. "Optimal monetary policy in a micro-founded model with parameter uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 399-431, February.
    5. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
    6. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003 291, Society for Computational Economics.
    7. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
    8. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1359-1377, August.
    9. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    10. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    11. Srour, Gabriel, 1999. "Inflation Targeting under Uncertainty," Technical Reports 85, Bank of Canada.
    12. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, June.
    13. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
    14. Pearlman, Joseph & Currie, David & Levine, Paul, 1986. "Rational expectations models with partial information," Economic Modelling, Elsevier, vol. 3(2), pages 90-105, April.
    15. repec:fth:harver:1435 is not listed on IDEAS
    16. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    17. Angeloni, Ignazio & Coenen, Günter & Smets, Frank, 2003. "Persistence, the transmission mechanism and robust monetary policy," Working Paper Series 0250, European Central Bank.
    18. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
    19. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
    20. repec:cup:cbooks:9780521788885 is not listed on IDEAS
    21. Levin, Andrew T. & Moessner, Richhild, 2005. "Inflation persistence and monetary policy design: an overview," Working Paper Series 0539, European Central Bank.
    22. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
    23. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
    24. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
    25. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
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