Learning with uncertain inflation target

Abstract

This paper studies the effects of a temporary increase in the inflation target in a model with adaptive learning and imperfect credibility of the central bank. In such a setup the private sector has to learn the model governing the economy and assess if the change in the interest rate is due to a standard interest rate shock or to a persistent shock to the inflation target. We find that the analytical condition that guarantees asymptotical E-stability under full credibility is the same that we obtain for the calibrated version of our model under imperfect credibility. Under full credibility the transition to the long-run equilibrium is faster and the variance of inflation is lower. Our results are consistent with the view that increasing the inflation target can be used as a policy instrument without unanchoring expectations.