PROBING POTENTIAL OUTPUT: MONETARY POLICY, CREDIBILITY AND OPTIMAL LEARNING UNDER UNCERTAINTY

The effective conduct of monetary policy is hampered by uncertainty surrounding the level of potential output. Here, the case for following a more aggressive policy to learn about the economy is considered in a model where potential output is changing over time. Following such a policy may be referred to as probing or experimenting.In this model, with parameters calibrated to recent Canadian data, the optimal amount of probing is small and increases only a little with credibility. Only for unrealistically large amounts of uncertainty does the optimal policy with probing diverge significantly from a policy that ignores learning, and even then, for most forms of uncertainty, the optimal amount of probing diminishes as credibility rises.