Uncertainty about Perceived Inflation Target and Monetary Policy. Paper presented at the Bundesbank-Federal Reserve

We analyse the interaction between private agents ’ uncertainty about in-flation target and the central bank’s data uncertainty. In our model, private agents update their perceived inflation target and the central bank estimates unobservable economic shocks as well as the perceived inflation target. Un-der those two uncertainties, the learning process of both private agents and the central bank causes higher order beliefs to become relevant, and this mechanism is capable of generating high persistence and volatility of infla-tion even though the underlying shocks are purely transitory. We also find that the persistence and volatility become smaller as the inflation target be-comes more credible, that is, the private agents ’ uncertainty about inflation target (and hence the bank’s data uncertainty) diminishes. ∗The authors are grateful for comments from Nicoletta Baniti, Martin Bodenstein, Anton Braun