Ambiguity, monetary policy and trend inflation

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 13 November 2015

Working Paper No. 565
By Riccardo M Masolo and Francesca Monti 

We develop a model that can explain the evolution of trend inflation in the United States in the three decades before the Great Recession as a function of the reduction in uncertainty about the monetary policy maker’s behaviour. The model features ambiguity-averse agents and ambiguity regarding the conduct of monetary policy, but is otherwise standard. Trend inflation arises endogenously and has these determinants: the strength with which the central bank responds to inflation, the degree of uncertainty about monetary policy perceived by the private sector, and, if it exists, the inflation target. Given the importance of monetary policy for the determination of trend inflation, we also study optimal monetary policy in the case of lingering ambiguity.

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