Central Bank Transparency and Nonlinear Learning Dynamics

Central bank communication plays an important role in shaping market participants' expectations. This paper studies a simple nonlinear model of monetary policy in which agents have incomplete information about the economic environment. It shows that agents' learning and the dynamics of the economy are heavily affected by central bank transparency about its policy rule. A central bank that does not communicate its rule can induce 'learning equilibria' in which the economy alternates between periods of deflation coupled with low output and periods of high economic activity with excessive inflation. More generally, initial beliefs that are arbitrarily close to the inflation target equilibrium can result in complex economic dynamics, resulting in welfare-reducing fluctuations. On the contrary, central bank communication of policy rules helps stabilize expectations around the inflation target equilibrium

Central Bank Transparency under Model Uncertainty

This paper explores the effects of central bank transparency on the performance of optimal inflation targeting rules. I assume that both the central bank and the private sector face uncertainty about the correct model of the economy and have to learn. A transparent central bank can reduce one source of uncertainty for private agents by communicating its policy rule to the public. The paper shows that central bank transparency plays a crucial role in stabilizing the agents' learning process and expectations. By contrast, lack of transparency can lead to expectations-driven fluctuations that have destabilizing effects on the economy, even when the central bank has adopted optimal policie

Comparing Forecast-Based and Backward-Looking Taylor Rules: A Global Analysis

This paper examines the performance of forecast-based nonlinear Taylor rules in a class of simple microfunded models. The paper shows that even if the policy rule leads to a locally determinate (and stable) inflation target, there exist other learnable 'global' equilibria such as cycles and sunspots. Moreover, under learning dynamics, the economy can fall into a liquidity trap. By contrast, more backward-looking and 'active' Taylor rules guarantee that the unique learnable equilibrium is the inflation target. This result is robust to different specifications of the role of money, price stickiness, and the trading environmen

On the Perils of Stabilizing Prices When Agents are Learning.

We show that price level stabilization is not optimal in an economy where agents have incomplete knowledge about the policy implemented and try to learn it. A systematically more accommodative policy than what agents expect generates short term gains without triggering an abrupt loss of con- fidence, since agents update expectations sluggishly. In the long run agents learn the policy implemented, 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

The Cross-Sectional Distribution of Price Stickiness Implied by Aggregate Data

Using only aggregate data as observables, we estimate multisector sticky-price models for twelve countries, allowing the degree of price stickiness to vary across sectors. We use a specification that allows us to extract information about the underlying cross-sectional distribution from aggregate data. Identification is possible because sectors play different roles in determining the response of aggregate variables to shocks at different frequencies: sectors where prices are more sticky are relatively more important in determining the low-frequency response. We find that the inferred distributions of price stickiness conform quite well with empirical distributions constructed from the available microeconomic evidence on price setting. We then explore our Bayesian approach to combine the aggregate time-series data with the microeconomic information on the distributions of price rigidity, and re-estimate the models for the United States, Denmark, and Japan. Our results show that allowing for this type of heterogeneity is critically important to understanding the joint dynamics of output and prices, and it constitutes a step toward reconciling the extent of nominal price rigidity implied by aggregate data with the evidence from price micro data

Fiscal Foundations of Inflation: Imperfect Knowledge

This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence, the scale and composition of the public debt matter for inflation. High and moderate duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments conducted in an estimated model reveal that the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods if US debt levels had been those observed in Italy or Japan