Working Paper: CEPR ID: DP18235
Authors: Spencer Krane; Leonardo Melosi; Matthias Rottner
Abstract: We examine how private sector agents might learn a new monetary strategy in a stochastic environment in which large inflationary and deflationary shocks may occur unexpectedly. We consider a central bank that adopts a new asymmetric average inflation targeting rule aimed at countering the disinflationary bias imparted by the effective lower bound (ELB). The new rule is announced while at the ELB. The most crucial time for learning runs from when rates would be near liftoff under the old strategy through early liftoff under the new rule. Recessionary shocks during this time could delay learning while large inflationary shocks could outright stop it, inhibiting the ability of the new strategy to address the costs associated with the ELB. A large inflation surprise may thus give rise to a novel policy dilemma: The central bank could offset some of the inflation-induced learning loss by being even more accommodative than its new strategy, but this decision comes at the cost of higher near-term inflation and greater uncertainty about monetary policy.
Keywords: New framework; Central banks; Communications; Deflationary bias; Inflation surprises; Asymmetric average inflation targeting; Imperfect credibility; Liftoff; Bayesian learning
JEL Codes: E52; C63; E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central bank's announcement of a new asymmetric average inflation targeting rule while at the ELB (E52) | Agents' learning about monetary policy (E19) |
| Recessionary shocks (E32) | Agents' ability to learn (D83) |
| Large inflationary shocks (E31) | Agents' ability to learn (D83) |
| Central bank's accommodative policy (E52) | Near-term inflation (E31) |
| Central bank's accommodative policy (E52) | Uncertainty about future monetary policy (E49) |
| Agents' learning process (D84) | Output outcomes (Y10) |
| Agents' learning process (D84) | Inflation outcomes (E31) |