Constrained Discretion and Central Bank Transparency
Abstract: We develop and estimate a general equilibrium model in which monetary policy can deviate from active inflation stabilization and agents face uncertainty about the nature of these deviations. When observing a deviation, agents conduct Bayesian learning to infer its likely duration. Under constrained discretion, only short deviations occur: Agents are confident about a prompt return to the active regime, macroeconomic uncertainty is low, welfare is high. However, if a deviation persists, agents? beliefs start drifting, uncertainty accelerates, and welfare declines. If the duration of the deviations is announced, uncertainty follows a reverse path. For the U.S. transparency lowers uncertainty and increases welfare.
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Description: Full text
Provider: Federal Reserve Bank of Chicago
Part of Series: Working Paper Series
Publication Date: 2014-07-01
Pages: 55 pages