Uncertainty over Models and Data: The Rise and Fall of American Inflation (JMCB 2012)

Journal of Money, Credit and Banking

March-April 2012

draft

Economic agents who are uncertain of their economic model learn, and this learning is sensitive to the presence of data uncertainty. I investigate this idea in a framework that successfully describes inflation as a learning Federal Reserve’s optimal policy but fails to satisfactorily motivate these policy shifts. I modify the framework to account for data uncertainty: the learning process is made more sluggish by its presence. Consequently, the estimated model provides an explanation for the rise and fall in inflation: the concurrent rise and fall in the perceived Philips curve trade-off between inflation and unemployment.

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