Parameter Uncertainty and Inflation Dynamics in a Model with Asymmetric Central Bank Preferences
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Date
2016
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Economic Modelling
Abstract
This paper exploits the Lucas’ (1973) signal extraction model to study the effect of uncertainty in the outputinflation
trade-off on inflation, using a monetary model with asymmetric central bank preferences over inflation
and output. We show that the implication of the uncertainty is two-fold: firstly, it causes the interaction of
output and volatility of monetary policy to influence inflation movements so that, higher volatility in monetary
policy causes inflation to rise. Secondly, as suggested in an optimal rule, it causes output to contract by less
whenever inflation increases above the target, and to expand by less whenever inflation is below the target. We
also find that the Reserve Bank’s asymmetric aversion to inflation stabilization explains inflation movements
significantly, and that the monetary authority seems to penalize more for inflationary rather than deflationary
pressures. Overall, the Bank’s deflationary bias would allow for a relatively flat output-inflation trade-off, which
could be helpful for economic stability.
Description
Keywords
Monetary policy, Asymmetric preferences, Inflation, Uncertainty
Citation
Chesang, L.K., & Naraidoo, R. (2016). Parameter uncertainty and inflation dynamics in a model with asymmetric central bank preferences. Economic Modelling, Elsevier, 56, 1-10.