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Constrained Discretion and Central Bank Transparency

Listed author(s):
  • Francesco Bianchi
  • Leonardo Melosi

We develop and estimate a general equilibrium model in which monetary policy can deviate from active inflation stabilization and agents face uncertainty about the nature of these deviations. When observing a deviation, agents conduct Bayesian learning to infer its likely duration. Under constrained discretion, only short deviations occur: Agents are confident about a prompt return to the active regime, macroeconomic uncertainty is low, welfare is high. However, if a deviation persists, agents' beliefs start drifting, uncertainty accelerates, and welfare declines. If the duration of the deviations is announced, uncertainty follows a reverse path. When estimated to match past U.S. experience, our model suggests that transparency lowers uncertainty and increases welfare.

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File URL: http://www.nber.org/papers/w20566.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20566.

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Date of creation: Oct 2014
Handle: RePEc:nbr:nberwo:20566
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