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Learning the monetary/fiscal interaction under trend inflation

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  • By Anna Florio
  • Alessandro Gobbi
Abstract
How does a higher inflation target affect determinacy and learnability of rational expectations equilibria under alternative monetary/fiscal policy mixes in new Keynesian models? What is the role of central bank transparency? This article proves that in a non-Ricardian regime, determinacy and learnability conditions are insensitive to changes in trend inflation and to transparency issues: expectations stabilization requires taxes to react weakly to government debt. Conversely, a higher inflation target always destabilizes expectations under active monetary regimes. In a Ricardian regime, raising the inflation target requires a more hawkish central bank to attain determinacy. However, determinacy implies learnability only when agents are aware of both the inflation target and the central bank reaction function. If agents need to learn a positive inflation target, active monetary regimes are unstable. Therefore, fully disclosing the reaction function, including the target inflation rate, greatly increases the central bank’s effectiveness in stabilizing expectations.

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  • By Anna Florio & Alessandro Gobbi, 2015. "Learning the monetary/fiscal interaction under trend inflation," Oxford Economic Papers, Oxford University Press, vol. 67(4), pages 1146-1164.
    • Handle: RePEc:oup:oxecpp:v:67:y:2015:i:4:p:1146-1164.
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    File URL: http://hdl.handle.net/10.1093/oep/gpv045
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    References listed on IDEAS

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    Cited by:

    1. Ascari, Guido & Florio, Anna & Gobbi, Alessandro, 2017. "Transparency, expectations anchoring and inflation target," European Economic Review, Elsevier, vol. 91(C), pages 261-273.
    2. Tesfaselassie, Mewael F., 2016. "The impact of disembodied technological progress on working hours," Kiel Working Papers 2026, Kiel Institute for the World Economy (IfW Kiel).
    3. Ascari, Guido & Florio, Anna & Gobbi, Alessandro, 2018. "High trend inflation and passive monetary detours," Economics Letters, Elsevier, vol. 172(C), pages 138-142.

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