Pitfalls of monetary policy under incomplete information: imprecise indicators and real indeterminacy

Can a strategy of targeting macro projections be the only guide for monetary policy actions, or could it cause macroeconomic instability in the face of imprecise information? The paper examines how the precision of the indicators affects determinacy in a model with partial information and an optimizing central bank. When the information on endogenous variables is noisy, the central bank acts too timidly and sunspots arise; relying on information on exogenous variables such as potential output can also induce too much caution in response to inflation. Simple rules which impose a large reaction to nominal variables, irrespective of their information content, may be needed to supply an anchor for prices. Appointing a “conservative” central banker may also be appropriate in presence of large uncertainty, irrespective of time inconsistency considerations, as he responds less timidly to signs of inflation or deflation when their interpretation is difficult.