Managing Disinflation under Uncertainty

Mewael F. Tesfaselassie and Eric Schaling ()

Kiel Working Papers from Kiel Institute for the World Economy

Abstract: In this paper we analyze disinflation policy when a central bank has imperfect information about private sector inflation expectations but learns about them from economic outcomes, which are in part the result of the disinflation policy. The form of uncertainty is manifested as uncertainty about the effect of past disinflation policy on current output gap. Thus current as well as past policy actions matter for output gap determination. We derive the optimal policy under learning (DOP) and compare it two limiting cases---certainty equivalence policy (CEP) and cautionary policy (CP). It turns out that under the DOP inflation stay between the levels implied by the CEP and the CP. A novel result is that this holds irrespective of the initial level of inflation. Moreover, while at high levels of inherited inflation the DOP moves closer to the CEP, at low levels of inherited inflation the DOP resembles the CP

Keywords: Learning; Inflation Expectations; Disinflation Policy; Separation Principle; Kalman Filter; Optimal Control (search for similar items in EconPapers)
JEL-codes: C53 E42 E52 F33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2008-06
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Persistent link: http://EconPapers.repec.org/RePEc:kie:kieliw:1429

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