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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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  14. Tim W. Cogley & Thomas J. Sargent, 2005. "Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making," Working Papers 523, University of California, Davis, Department of Economics.
  15. Timothy Cogley & Giorgio E. Primiceri & Thomas J. Sargent, 2008. "Inflation-Gap Persistence in the U.S," NBER Working Papers 13749, National Bureau of Economic Research, Inc.
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  18. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive Learning, Persistence, and Optimal Monetary Policy," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 376-385, 04-05.
  19. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
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