Working Paper: CEPR ID: DP3568
Authors: Joao Mauricio Rosal; Michael Spagat
Abstract: We study the problem of a central bank whose policy actions simultaneously affect the information flow about its expectations-augmented Phillips curve and its reputation for toughness in fighting inflation. In an environment with an unknown relationship between inflation surprises and output, big inflation surprises yield big short-term output gains and a strong information flow. Yet optimal policy is very conservative because inflation surprises yield information that increases the volatility of both future inflationary expectations and inflation itself. In fact, the more there is that can be learned about the Phillips curve the less does optimal policy aim towards learning.
Keywords: central bank conservatism; experimentation; learning; monetary policy; reputation
JEL Codes: D80; D83; E50; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher structural uncertainty about the relationship between inflation surprises and output (D89) | more conservative monetary policy by the central bank (E52) |
| inflation surprises (E31) | significant short-term output gains (E23) |
| inflation surprises (E31) | long-term volatility in inflationary expectations (E31) |
| long-term volatility in inflationary expectations (E31) | conservative approach by the central bank (E58) |
| high structural uncertainty (D89) | conservative behavior of the central bank (E58) |
| higher structural uncertainty (D89) | fear of large inflationary surprises (E31) |
| fear of large inflationary surprises (E31) | harm to central bank's reputation (E58) |
| harm to central bank's reputation (E58) | destabilize future policy (E60) |