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Optimal disinflation under learning

  • Timothy Cogley
  • Christian Matthes
  • Argia M. Sbordone

We model transitional dynamics that emerge after the adoption of a new monetary policy rule. We assume that private agents learn about the new policy via Bayesian updating, and we study how learning affects the nature of the transition and the choice of a new rule. Temporarily explosive dynamics can emerge when there is substantial disagreement between actual and perceived policies. These dynamics make the transition highly volatile and dominate expected loss. The emergence of temporarily explosive paths depends more on uncertainty about policy-feedback parameters than about the long-run inflation target. For that reason, the central bank can at least achieve low average inflation. Its ability to move feedback parameters away from initial beliefs, however, is more constrained.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 524.

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Date of creation: 2011
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Handle: RePEc:fip:fednsr:524
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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
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  8. Olivier Coibion & Yuriy Gorodnichenko, 2011. "Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation," American Economic Review, American Economic Association, vol. 101(1), pages 341-70, February.
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  10. Gaspar, Vítor & Smets, Frank & Vestin, David, 2006. "Adaptive learning, persistence, and optimal monetary policy," Working Paper Series 0644, European Central Bank.
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  12. Timothy Cogley & Giorgio E. Primiceri & Thomas J. Sargent, 2010. "Inflation-Gap Persistence in the US," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 43-69, January.
  13. In-Koo Cho & Noah Williams & Thomas J. Sargent, 2002. "Escaping Nash Inflation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 1-40.
  14. Elmar Mertens, 2008. "Managing Beliefs about Monetary Policy under Discretion?," Working Papers 08.02, Swiss National Bank, Study Center Gerzensee.
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  17. repec:oup:restud:v:72:y:2005:i:3:p:821-852 is not listed on IDEAS
  18. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-22, December.
  19. Elmar Mertens, 2010. "Discreet Commitments and Discretion of Policymakers with Private Information," 2010 Meeting Papers 763, Society for Economic Dynamics.
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