The Inflation Bias Result Revisited

Abstract

The Kydland-Prescott, Barro-Gordon inflation bias result relies on the presumption that policymakers aim at achieving a level of employment above the normal level. This presumption has been recently questioned by both academics and policymakers on the ground of realism. This note shows that even if policymakers are content with the normal level of employment there is an inflation bias if the following two realistic conditions are satisfied. The central bank is uncertain about the future state of the economy and is more sensitive to policy misses leading to employment below the normal level that to policy misses leading to employment above it. The note also shows that there is reason to believe the bias today is smaller than in the past and discusses the implications of the analysis for the design of legal central bank objectives.

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