The loss from uncertainty on policy targets

What is the welfare loss arising from uncertainty about true policy targets? We quantify these effects in a DSGE model where private agents are unable to distinguish between temporary shocks to potential output and to the inflation target. Agents use optimal filtering techniques to construct estimates of the unknown variables. We find that the welfare costs of not observing the inflation target and potential output are relevant even in the case of a small measurement error. We also show that, in our framework, uncertainty about the inflation target is more costly than uncertainty about potential output.

► DSGE model where the private sector does not observe policy targets ► Interest rate is used as a signal to estimate the unobservable policy targets. ► Relevant welfare costs when the private sector does not observe policy targets. ► Uncertainty about the inflation target entails a higher welfare loss.