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On the perils of stabilizing prices when agents are learning

Mele, Antonio, Molnár, Krisztina and Santoro, Sergio (2019) On the perils of stabilizing prices when agents are learning Journal of Monetary Economics.

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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.

Item Type: Article
Divisions : Faculty of Arts and Social Sciences > School of Economics
Authors :
NameEmailORCID
Mele, Antonioa.mele@surrey.ac.uk
Molnár, Krisztina
Santoro, Sergio
Date : 13 August 2019
DOI : 10.1016/j.jmoneco.2019.08.006
Copyright Disclaimer : © 2019. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/
Uncontrolled Keywords : Optimal monetary policy; Price level stabilization; Inflation stabilization; Learning
Depositing User : Clive Harris
Date Deposited : 06 Sep 2019 07:32
Last Modified : 06 Sep 2019 07:32
URI: http://epubs.surrey.ac.uk/id/eprint/852559

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