On the perils of stabilizing prices when agents are learning

Antonio Mele, Krisztina Molnár and Sergio Santoro

Journal of Monetary Economics, 2020, vol. 115, issue C, 339-353

Abstract: The main advantage of price level stabilization compared with inflation stabilization rests on the central bank’s ability to shape expectations. We show that stabilizing prices is no longer optimal when the central bank can shape expectations of agents with incomplete knowledge, who have to learn about the policy implemented. Disinflating in the short run more than agents expect generates short-term gains without triggering an abrupt loss of confidence, because agents update expectations sluggishly. Following this policy, in the long run, the central bank loses the ability to shape agents’ beliefs, and the economy converges to a rational expectations equilibrium in which policy does not stabilize prices, economic volatility is high, and agents suffer the corresponding welfare losses. However, these losses are outweighed by short-term gains from the learning phase.

Keywords: Optimal monetary policy; Price level stabilization; Inflation stabilization; Learning (search for similar items in EconPapers)
JEL-codes: C62 D83 D84 E52 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Related works:
Working Paper: On the perils of stabilizing prices when agents are learning (2018)
Working Paper: On the Perils of Stabilizing Prices when Agents are Learning (2015)
Working Paper: On the perils of stabilizing prices when agents are learning (2015)
Working Paper: On the perils of stabilizing prices when agents are learning (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:115:y:2020:i:c:p:339-353

DOI: 10.1016/j.jmoneco.2019.08.006

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