Inflation contract,central bank transparency and model uncertainty |
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Authors: | Meixing Dai Eleftherios Spyromitros |
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Institution: | 1. BETA, University of Strasbourg, 61, avenue de la Forêt Noire, 67085 Strasbourg Cedex, France;2. Department of International Economic Relations and Development, Demokritus University of Thrace, Komotini Campus 69100, Greece |
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Abstract: | Using a New-Keynesian model subject to misspecifications, we examine how the robust monetary policy could be modified by a linear inflation contract when a central bank is opaque about its preference for model robustness. It is shown that a central bank must limit this preference and opacity about it to ensure the dynamic stability of the economy. An optimal inflation contract with a zero penalty rate provides no incentive for a central bank to be opaque. The latter must rebalance the benefit of avoiding very bad outcomes in worst case scenarios and the economic costs due to higher macroeconomic volatility. |
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