On the Perils of Stabilizing Prices when Agents are Learning

41 Pages Posted: 13 Nov 2018

See all articles by Antonio Mele

Antonio Mele

University of Surrey

Krisztina Molnar

Norwegian School of Economics (NHH) - Department of Economics

Sergio Santoro

Bank of Italy

Multiple version iconThere are 3 versions of this paper

Date Written: October 26, 2018

Abstract

The main advantage of price level stabilization compared with inflation stabilization rests on the central bank's ability to shape expectations. We show that stabilizing prices is no longer optimal when the central bank can shape expectations of agents with incomplete knowledge, who have to learn about the policy implemented. Disinflating in the short run more than agents expect generates short-term gains without triggering an abrupt loss of confidence, because agents update expectations sluggishly. Following this policy, in the long run, the central bank loses the ability to shape agents' beliefs, and the economy converges to a rational expectations equilibrium in which policy does not stabilize prices, economic volatility is high, and agents suffer the corresponding welfare losses. However, these losses are outweighed by short-term gains from the learning phase.

JEL Classification: C62, D83, D84, E52

Suggested Citation

Mele, Antonio and Molnar, Krisztina and Santoro, Sergio, On the Perils of Stabilizing Prices when Agents are Learning (October 26, 2018). NHH Dept. of Economics Discussion Paper No. 22/2018. Available at SSRN: https://ssrn.com/abstract=3281565 or http://dx.doi.org/10.2139/ssrn.3281565

Antonio Mele

University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Krisztina Molnar (Contact Author)

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

Sergio Santoro

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
3
Abstract Views
85
PlumX Metrics
!

Under construction: SSRN citations while be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information