Policy uncertainty can magnify cost shocks – BoI paper

A working paper published by the Bank of Italy studies the interaction of cost‐push shocks with monetary policy.

In Disinflationary shocks and inflation target uncertainty, Stefano Neri and Tiziano Ropele note that in New Keynesian models, favourable cost-push shocks lower inflation and increase output. But if a central bank does not target inflation perfectly, such shocks can become contractionary.

The authors present a small-scale New Keynesian model of the economy. Their model includes a