Monetary Policy and Inflationary Shocks Under Imperfect Credibility

Matthieu DARRACQ PARIES () and Stéphane Moyen ()

No 1065, Working Paper Series from European Central Bank

Abstract: This paper quantifies the deterioration of achievable stabilization outcomes when monetary policy operates under imperfect credibility and weak anchoring of long-term expectations. Within a medium-scale DSGE model, we introduce through a simple signal extraction problem, an imperfect knowledge configuration where price and wage setters wrongly doubt about the determination of the central bank to leave unchanged its long-term inflation objective in the face of inflationary shocks. The magnitude of private sector learning has been calibrated to match the volatility of US inflation expectations at long horizons. Given such illustrative calibrations, we find that the costs of maintaining a given inflation volatility under weak credibility could amount to 0.25 pp of output gap standard deviation. JEL Classification: E4, E5, F4.

Keywords: Monetary policy; Imperfect credibility; Signal extraction. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2009-06
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