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Managing Disinflation under Uncertainty

Author

Listed:
  • Mewael F. Tesfaselassie
  • Eric Schaling

Abstract

In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases -- certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP.

Suggested Citation

  • Mewael F. Tesfaselassie & Eric Schaling, 2008. "Managing Disinflation under Uncertainty," CDMA Conference Paper Series 0812, Centre for Dynamic Macroeconomic Analysis.
    • Handle: RePEc:san:cdmacp:0812
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    File URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0812.pdf
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    References listed on IDEAS

    as
    1. Yetman, James, 2003. "Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty," Journal of Macroeconomics, Elsevier, vol. 25(3), pages 311-330, September.
    2. Mewael F. Tesfaselassie & Eric Schaling & Sylvester Eijffinger, 2011. "Learning about the Term Structure and Optimal Rules for Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(8), pages 1685-1706, December.
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    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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