Keywords: optimal control with unknown parameters, Bayesian learning, monetary policy, inflation targeting
Abstract: Since central banks have limited information concerning the
transmission channel of monetary policy, they are faced with
the difficult task of simultaneously controlling the policy
target and estimating the impact of policy actions. A tradeoff
between estimation and control arises because policy actions
influence estimation and provide information which may improve
future performance. I analyze this tradeoff in a simple model
with parameter uncertainty and conduct dynamics simulations of the
policymaker's decision problem in the presence of the type of
uncertainties that arose in the wake of German reunification.
A policy that separates learning from control may induce a
persistent upward bias in money growth and inflation, just as
observed after unification. In contrast, the optimal learning
strategy which exploits the tradeoff between control and estimation
significantly improves stabilization performance and reduces the
likelihood of inflationary bias.
Full paper (3356 KB PDF)
Home | FEDS | List of 1999 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: October 20, 1999