Bulletin n. 3/2007 | ||
December 2007 | ||
Willy Spanjers |
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Central banks and ambiguity | ||
in International Review of Economics and Finance , Volume 17, Issue 1 , 2008 , 85-102 | ||
The purpose of this paper is to discuss the effects of ambiguity (or ‘non-calculable risk’) on the public's expectations about inflation and its impact on central bank policy. The effects of ambiguity are addressed in a textbook setting with a short run aggregate supply curve. Ambiguity about monetary policy can be characterised as a loss of central bank credibility. When the public is pessimistically inclined, its consequences are excessive inflation expectations and a national income below its natural rate. This result is obtained both in the context of ‘discretion’ and of ‘inflation targeting’, although the impact of ambiguity is less pronounced in the latter case. If the public is optimistic with respect to the monetary policy of the central bank, loss of credibility has no impact. | ||