DP3568 Structural Uncertainty and Central Bank Conservatism: The Ignorant Should Keep Their Eyes Shut

• Michael Spagat Joao Mauricio Rosal
20 Oct 2002

We study the problem of a central bank whose policy actions simultaneously affect the information flow about its expectations-augmented Phillips curve and its reputation for toughness in fighting inflation. In an environment with an unknown relationship between inflation surprises and output, big inflation surprises yield big short-term output gains and a strong information flow. Yet optimal policy is very conservative because inflation surprises yield information that increases the volatility of both future inflationary expectations and inflation itself. In fact, the more there is that can be learned about the Phillips curve the less does optimal policy aim towards learning.