Endogenous monetary policy with unobserved potential output

Alex Cukierman () and Francesco Lippi

No 493, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research Department

Abstract: This paper characterizes endogenous monetary policy when policymakers are uncertain about the extent to which movements in output and inflation are due to changes in potential output or to cyclical demand and cost shocks. We refer to this informational limitation as the “information problem” (IP). Main results of the paper are: 1. Policy is likely to be excessively loose (restrictive) for some time when there is a large decrease (increase) in potential output in comparison with a full information benchmark. 2. Errors in forecasting potential output and the output gap are generally serially correlated. These ndings provide a partial explanation for the inflation of the seventies and the price stability of the nineties. 3. A quantitative assessment, based on an empirical model of the US economy developed by Rudebusch and Svensson (1999), indicates that during and following periods of large changes in potential output the IP significantly affects the dynamics of inflation and output. 4. The increase in the Fed’s conservativeness between the seventies and the nineties, and a more realistic appreciation of the uncertainties surrounding potential output in the second period, imply that the IP problem had a stronger impact in the seventies than in the nineties.

Keywords: monetary policy; potential output; filtering; inflation; output gap (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-for, nep-mac and nep-mon
Date: Written
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Related works:
Working Paper: Endogenous Monetary Policy with Unobserved Potential Output (2003)
Working Paper: Endogenous Monetary Policy with Unobserved Potential Output (2003)
Journal Article: Endogenous monetary policy with unobserved potential output (2005)
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Persistent link: http://EconPapers.repec.org/RePEc:bdi:wptemi:td_493_04

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