Monetary Policy with Uncertain Inflation Persistence

By Luis Brandão-Marques, Roland Meeks, Vina Nguyen

March 8, 2024

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Format: Chicago

Luis Brandão-Marques, Roland Meeks, and Vina Nguyen. Monetary Policy with Uncertain Inflation Persistence, (USA: International Monetary Fund, 2024) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

When uncertain about inflation persistence, central banks are well-advised to adopt a robust strategy when setting interest rates. This robust approach, characterized by a "better safe than sorry" philosophy, entails incurring a modest cost to safeguard against a protracted period of deviating inflation. Applied to the post-pandemic period of exceptional uncertainty and elevated inflation, this strategy would have called for a tightening bias. Specifically, a high level of uncertainty surrounding wage, profit, and price dynamics requires a more front-loaded increase in interest rates compared to a baseline scenario which the policymaker fully understands how shocks to those variables are transmitted to inflation and output. This paper provides empirical evidence of such uncertainty and estimates a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model for the euro area to derive a robust interest rate path for the ECB which serves to illustrate the case for insuring against inflation turning out to have greater persistence.

Subject: Central bank policy rate, Financial services, Inflation, Inflation persistence, Labor, Output gap, Prices, Production, Wages

Keywords: Central and Eastern Europe, Central bank policy rate, Eastern Europe, Europe, IMF working paper 2024/47, Inflation, Inflation expectation, Inflation persistence, Monetary policy, Monetary Policy stance, Output gap, Policy rule parameter, Price Persistence, Robust policy, Uncertainty, Wage and price dynamics., Wages

Publication Details

Pages:

32
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2024/047
Stock No:

WPIEA2024047
ISBN:

9798400269394
ISSN:

1018-5941

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