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The Return of Inflation: Look-Through Policy Under Incomplete Information

Author

Listed:
  • Ginters BuÅ¡s

    (Latvijas Banka)

  • Guido Traficante

    (European University of Rome)

Abstract

This paper studies monetary policy in a New Keynesian model with incomplete information regarding the persistence of cost-push shocks. The central bank and the private sector gradually learn about the persistence of the shock as it propagates through the economy. The central bank adopts a look-through policy in response to temporary cost-push shocks; otherwise, it follows a Taylor rule. If agents initially believe the cost-push shock to be temporary, while the true shock is persistent, it takes some time for the central bank, acting initially under an incorrect assumption, to realise its mistake and switch to monetary tightening. As a result, the actual inflation is higher than in a complete information case. Data-dependent discretionary early liftoff strategies can partially mitigate the effects of the initial policy misjudgment. Contrary to the full-information conditions, the findings cast doubt on the effectiveness of look-through policies in environments of incomplete information, irrespective of the actual persistence of the cost-push shock.

Suggested Citation

  • Ginters BuÅ¡s & Guido Traficante, 2025. "The Return of Inflation: Look-Through Policy Under Incomplete Information," Working Papers 2025/02, Latvijas Banka.
    • Handle: RePEc:ltv:wpaper:202502
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    File URL: https://datnes.latvijasbanka.lv/papers/WP_2_2025.pdf
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    More about this item

    Keywords

    monetary policy; imperfect information; cost-push shock; high inflation;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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