Monetary Policy with Uncertain Inflation Persistence

Luis Brandão-Marques, Roland Meeks and Vina Nguyen
Authors registered in the RePEc Author Service: Luis Brandao Marques

No 2024/047, IMF Working Papers from International Monetary Fund

Abstract: When uncertain about inflation persistence, central banks are well-advised to adopt a robust strategy when setting interest rates. This robust approach, characterized by a "better safe than sorry" philosophy, entails incurring a modest cost to safeguard against a protracted period of deviating inflation. Applied to the post-pandemic period of exceptional uncertainty and elevated inflation, this strategy would have called for a tightening bias. Specifically, a high level of uncertainty surrounding wage, profit, and price dynamics requires a more front-loaded increase in interest rates compared to a baseline scenario which the policymaker fully understands how shocks to those variables are transmitted to inflation and output. This paper provides empirical evidence of such uncertainty and estimates a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model for the euro area to derive a robust interest rate path for the ECB which serves to illustrate the case for insuring against inflation turning out to have greater persistence.

Keywords: Robust policy; monetary policy; uncertainty; inflation persistence; wage and price dynamics.; Monetary Policy stance; policy rule parameter; price Persistence; IMF working paper 2024/47; inflation expectation; Inflation; Central bank policy rate; Output gap; Wages; Europe; Central and Eastern Europe; Eastern Europe (search for similar items in EconPapers)
Pages: 32
Date: 2024-03-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mon
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