'Talking down monetary policy' – a note. Issue 20 (28th November 2017)

• Record Type: Journal Article
• Authors: Tillmann, Peter
• Is Part Of: Applied economics letters. Volume 24:Issue 20(2017)
• Page Start: 1443
• Page End: 1447
• Publication Date: 2017-11-28
• Subjects: Optimal monetary policy -- policy effectiveness -- shocks -- inflation -- misperception; E31 -- E32 -- E58; Economics -- Periodicals; Economics, Mathematical -- Periodicals; 330
• DOI: 10.1080/13504851.2017.1282140
• Languages: English
• ISSNs: 1350-4851

Abstract

ABSTRACT: There is a recent debate about whether ultra-expansionary monetary policy is no longer effective in stimulating demand, a concern often voiced in the euro area in light of persistently low and even negative inflation. As a response, the European Central Bank (ECB) warns against 'talking down monetary policy' (ECB Vice-President Vítor Constâncio, 2016). This note uses a textbook model of optimal monetary policy to study a situation in which the public misperceives the interest rate elasticity of aggregate demand, which reflects policy effectiveness. We show that as a result of underestimating policy effectiveness demand shocks can no longer be stabilized perfectly, thus resulting in inefficient inflation and output dynamics. In the presence of misperceptions, a negative demand shock leads to a prolonged period of negative inflation rates.