Optimal Disinflation Under Learning

40 Pages Posted: 10 Nov 2011

See all articles by Timothy Cogley

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics

Christian Matthes

Federal Reserve Bank of Richmond

Argia M. Sbordone

Federal Reserve Bank of New York

Date Written: November 1, 2011

Abstract

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.

Keywords: inflation, monetary policy, learning, policy reforms, transitions

JEL Classification: E31, E52

Suggested Citation

Cogley, Timothy and Matthes, Christian and Sbordone, Argia M., Optimal Disinflation Under Learning (November 1, 2011). FRB of New York Staff Report No. 524. Available at SSRN: https://ssrn.com/abstract=1957678 or http://dx.doi.org/10.2139/ssrn.1957678

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
530-752-1581 (Phone)
530-752-9382 (Fax)

Christian Matthes

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Argia M. Sbordone (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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