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Adaptive learning and the use of forecasts in monetary policy

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  • Preston, Bruce

Abstract

This paper investigates monetary policy design when central bank and private-sector expectations differ. Private agents learn adaptively; the central bank has a possibly misspecified model of the economy. Successful implementation of optimal policy using inflation targeting rules requires the central bank to have complete knowledge of private agents' learning behavior. If the central bank mistakenly assumes private agents to have rational expectations when in fact they are learning, then policy rules frequently lead to divergent learning dynamics. However, if the central bank does not correctly understand agents' behavior, stabilization policy is best implemented by controlling the path of the price level rather than the inflation rate.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 11 (November)
Pages: 3661-3681

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:11:p:3661-3681

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Web page: http://www.elsevier.com/locate/jedc

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Keywords: Adaptive learning Monetary policy Targeting rules;

References

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  1. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, Elsevier, vol. 43(3), pages 607-654, June.
  2. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, Elsevier, vol. 11(2), pages 139-168.
  6. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  7. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  8. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series 0127, European Central Bank.
  9. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  10. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  11. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  12. Krisztina Molnár & Sergio Santoro, 2010. "Optimal Monetary Policy When Agents Are Learning," Working Paper, Norges Bank 2010/08, Norges Bank.
  13. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  14. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(3), pages 507-535, April.
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