Can Ignorance Make Central Banks Behave?

Christopher Canavan
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Christopher Canavan: Boston College, Postal: Dept. of Economics, Boston College, Chestnut Hill, MA 02467 USA

No 291., Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper presents a model in which "instrument uncertainty"-that is, an uncertain mapping from monetary policy to macroeconomic outcomes-may mitigate the inflationary bias problem that arises when efficient monetary policy rules are time- inconsistent. If the relation between monetary policy and macroeconomic outcomes is uncertain, the private sector has an incentive to scrutinize the past for clues about this relationship. This learning creates a link between past government behavior and present inflation expectations that the government can exploit to enhance its credibility. The model implies that the two conventional arguments for simple rules in monetary policy-one stressing the central bank's poor forecasting abilities and the other stressing the perils of discretion-may work at cross-purposes. Moreover, it provides an explanation of the cyclical behavior of inflation due to political cycles and of the correlation between the level and variance of inflation.

Keywords: instrument uncertainty; monetary policy; inflationary bias; time- inconsistency; learning. (search for similar items in EconPapers)
JEL-codes: D83 E31 E52 (search for similar items in EconPapers)
Pages: 17 pages
Date: 1995-07
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Persistent link: https://EconPapers.repec.org/RePEc:boc:bocoec:291

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