Trust and Monetary Policy

54 Pages Posted: 29 Mar 2022

See all articles by Paul De Grauwe

Paul De Grauwe

CESifo (Center for Economic Studies and Ifo Institute for Economic Research); London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Yuemei Ji

University College London - School of Slavonic and East European Studies

Multiple version iconThere are 2 versions of this paper

Date Written: March 2022

Abstract

We analyze how trust affects the transmission of negative demand and supply shocks. We define trust to have two dimensions: there is trust in the central bank's inflation target and trust in the future of economic activity. We use a behavioural macroeconomic model that is characterized by the fact that individuals lack the cognitive ability to understand the underlying model and to know the distribution of the shocks that hit the economy. We find, first, that when large negative demand shocks occur the subsequent trajectories taken by output gap and inflation typically coalesce around a good and a bad trajectory. Second, these good and bad trajectories are correlated with movements in trust. In the bad trajectories trust collapses, in the good trajectories it is not affected. This feature is stronger when a negative supply shock occurs than in the case of a negative demand shock. Third, initial conditions (history) matters. Unfavorable initial conditions drive the economy into a bad trajectory, favorable initial conditions produce good trajectories.

Suggested Citation

De Grauwe, Paul and De Grauwe, Paul and Ji, Yuemei, Trust and Monetary Policy (March 2022). CEPR Discussion Paper No. DP17087, Available at SSRN: https://ssrn.com/abstract=4069895

Paul De Grauwe (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Yuemei Ji

University College London - School of Slavonic and East European Studies ( email )

Malet Street
London WC1E 7HU
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
0
Abstract Views
186
PlumX Metrics