Optimized Taylor Rules for Disinflation When Agents are Learning

Cogley, Timothy; Matthes, Christian; Sbordone, Argia M.

Working Paper

Optimized Taylor Rules for Disinflation When Agents are Learning

Abstract: Highly volatile transition dynamics can emerge when a central bank disinflates while operating without full transparency. In our model, a central bank commits to a Taylor rule whose form is known but whose coefficient are not. Private agents learn about policy parameters via Bayesian updating. Under McCallum's (1999) timing protocol, temporarily explosive dynamics can arise, making the transition highly volatile. Locally-unstable dynamics emerge when there is substantial disagreement between actual and perceived feedback parameters. The central bank can achieve low average inflation, but its ability to adjust reaction coefficients is more limited.

Keywords: Inflation; Monetary policy; Learning; Policy reforms; Transitions;

JEL Classification: E31; E52;