Trust and monetary policy

Paul De Grauwe and Yuemei Ji ()

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We analyze how trust affects the transmission of negative demand and supply shocks using a behavioral macroeconomic model. We define trust to have two dimensions: trust in the central bank's inflation target and trust in the central bank's capacity to stabilize the business cycle. We find, first, that when large negative 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, and 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, in particular the initial state of inflation and output expectations, matter. Unfavorable initial expectations drive the economy into a bad trajectory, and favorable initial expectations produce good trajectories. Fourth, we analyze the sensitivity of our results with respect to the size of the shocks. Fifth, we derive implications of our results for our capacity of making forecasts about the effects of large demand and supply shocks.

Keywords: behavioral macroeconomics; monetary policy; trust (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2024-07-01
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mon and nep-soc
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published in Journal of Forecasting, 1, July, 2024, 43(4), pp. 903 - 931. ISSN: 0277-6693

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http://eprints.lse.ac.uk/120871/ Open access version. (application/pdf)

Related works:
Journal Article: Trust and monetary policy (2024)
Working Paper: Trust and Monetary Policy (2022)
Working Paper: Trust and monetary policy (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:120871

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