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The Effects of Transmission Uncertainty on the Flexibility-Credibility Tradeoff in Monetary Policy

  • Sénégas, Marc-Alexandre

    ()

    (GRAPE Universite Montesquieu - Bordeaux IV)

  • Vilmunen, Jouko

    ()

    (Bank of Finland Research)

In this paper we address the issue of how parameter uncertainty affects the optimal degree of central bank conservatism. The analysis is conducted in the standard macroeconomic model of a monetary policy game embedding an expectational Phillips-curve. Multiplicative "Brainard" uncertainty is added to the model. This means that the central bank's policy instrument has a stochastic impact on inflation. This type of uncertainty is particularly interesting, since it affects the credibility–flexibility tradeoff in monetary policymaking. We show that if the flexibility problem dominates, an increase in uncertainty reduces optimal conservatism. However, increases in uncertainty can also require increases in the optimal degree of conservatism. This happens when the central bank has a sufficiently large credibility problem. This is particularly clear in the case of the introduction of uncertainty at the margin. Furthermore, the coefficient of variation of inflation appears to contain useful information about the relative size of the credibility problem and, hence, about how incipient uncertainty can affect optimal conservatism in actual economies.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/9914.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 14/1999.

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Length: 37 pages
Date of creation: 08 Mar 1999
Date of revision:
Handle: RePEc:hhs:bofrdp:1999_014
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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  1. Alex Cukierman, 1992. "Central Bank Strategy, Credibility, and Independence: Theory and Evidence," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031981, June.
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  3. Letterie, Wilko, 1997. " Better Monetary Control May Decrease the Distortion of Stabilisation Policy: A Comment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 99(3), pages 463-70, September.
  4. Eric Schaling & Marco Hoeberichts & Sylvester Eijffinger, 1998. "Incentive schemes for central bankers under uncertainty: inflation targets versus contracts," Bank of England working papers 88, Bank of England.
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  6. Pearce, Douglas K. & Sobue, Motoshi, 1997. "Uncertainty and the inflation bias of monetary policy," Economics Letters, Elsevier, vol. 57(2), pages 203-207, December.
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  8. Rudi Dornbusch & Carlo Favero & Francesco Giavazzi, 1998. "Immediate challenges for the European Central Bank," Economic Policy, CEPR;CES;MSH, vol. 13(26), pages 15-64, 04.
  9. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
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  11. Eijffinger, Sylvester C W & Hoeberichts, Marco & Schaling, Eric, 2000. "Why Money Talks and Wealth Whispers: Monetary Uncertainty and Mystique," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(2), pages 218-35, May.
  12. Muscatelli, V Anton, 1999. "Inflation Contracts and Inflation Targets under Uncertainty: Why We Might Need Conservative Central Bankers," Economica, London School of Economics and Political Science, vol. 66(262), pages 241-54, May.
  13. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  14. Clive Briault & Andrew Haldane & Mervyn King, 1996. "Independence and Accountability," Bank of England working papers 49, Bank of England.
  15. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  16. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
  17. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
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