Learning about belief about inflation target and Stabilisation Policy∗

We analyse the interaction between the lack of credibility (or uncertainty) regarding central bank’s inflation target and central bank’s stabilisation policy. We consider a model in which private sector is uncertain about the bank’s inflation target and update its beliefs on it. Furthermore, we assume that the bank cannot observe the private-sector belief about the inflation target as well as fundamental economic shocks, and has to estimate them. We consider the implications of this ‘double-guessing’ about inflation target. We show that this uncertainty generates a negative feedback on stabilisation policy by making the bank’s estimation of economic shocks more difficult. Also, it generates inflation persistence even when shocks are purely transitory. We also draw some implications of movements in yield curves in response to monetary policy changes. Very preliminary. Please do not circulate. Appendices missing. ∗Aoki thanks hospitality of the Bank of Japan, and the MCYT and FEDR (project No. SEC200203186) for financial support. The paper represents the views and analysis of the authors and should not be thought to represent those of the Bank of Japan.