Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty

Abstract

The effective conduct of monetary policy is complicated by uncertainty about the level of potential output. One possible response is for the central bank to “probe,” interpreted here as actively using its policy to learn about the level of potential output. I consider a simple calibrated model in the Canadian context and examine the relationship between credibility and optimal probing. For plausible parameter values, the optimal amount of probing is small and diminishes slightly as credibility rises. Only for unrealistically low levels of credibility or unrealistically large levels of uncertainty or volatility does the optimal policy diverge significantly from a policy that ignores learning.