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Monetary Policy and the Transition to Rational Expectations

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  • Giuseppe Ferrero

    ()
    (Bank of Italy, Economic Research Department)

Abstract

Under the assumption of bounded rationality, economic agents learn from their past mistaken predictions by combining new and old information to form new beliefs. The purpose of this paper is to examine how the policy-maker, by affecting private agents' learning process, determines the speed at which the economy converges to the rational expectation equilibrium. I find that by reacting strongly to private agents' expected inflation, a central bank would increase the speed of convergence. I assess the relevance of the transition period when looking at a criterion for evaluating monetary policy decisions and suggest that a fast convergence is not always suitable.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 499.

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Date of creation: Jun 2004
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Handle: RePEc:bdi:wptemi:td_499_04

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Keywords: Interest Rate Setting; Adaptive Learning; Rational Expectations; Speed of Convergence;

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References

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  1. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  2. Chryssi Giannitsarou, 2004. "Supply-side reforms and learning dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 36, Money Macro and Finance Research Group.
  3. Honkapohja, S. & Evans, G.W., 2000. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Helsinki, Department of Economics 481, Department of Economics.
  4. James Bullard & Kaushik Mitra, 2007. "Determinacy, Learnability, and Monetary Policy Inertia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1177-1212, 08.
  5. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  6. 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.
  7. Bray, Margaret, 1982. "Learning, estimation, and the stability of rational expectations," Journal of Economic Theory, Elsevier, vol. 26(2), pages 318-339, April.
  8. Athanasios Orphanides & John C. Williams, 2003. "Inflation scares and forecast-based monetary policy," Working Paper 2003-21, Federal Reserve Bank of Atlanta.
  9. Federico Cingano & Fabiano Schivardi, 2003. "Identifying the Sources of Local Productivity Growth," Temi di discussione (Economic working papers) 474, Bank of Italy, Economic Research and International Relations Area.
  10. Kosuke Aoki & Kalin Nikolov, 2004. "Rule-based monetary policy under central bank learning," Bank of England working papers 235, Bank of England.
  11. Albert Marcet & Juan P. Nicolini, 2003. "Recurrent Hyperinflations and Learning," American Economic Review, American Economic Association, vol. 93(5), pages 1476-1498, December.
  12. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  13. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  14. Paolo Finaldi Russo & Luigi Leva, 2004. "Il debito commerciale in Italia: quanto contano le motivazioni finanziarie?," Temi di discussione (Economic working papers) 496, Bank of Italy, Economic Research and International Relations Area.
  15. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
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Cited by:
  1. Eugenio Gaiotti & Alessandro Secchi, 2004. "Is there a cost channel of monetary policy transmission? An investigation into the pricing behaviour of 2,000 firms," Temi di discussione (Economic working papers) 525, Bank of Italy, Economic Research and International Relations Area.
  2. Alberto Locarno, 2007. "Imperfect Knowledge, Adaptive Learning, and the Bias Against Activist Monetary Policies," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 47-85, September.
  3. Martin Fukac, 2005. "Should Private Expectations Concern Central Bankers?," CERGE-EI Working Papers wp277, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  4. Krisztina Molnar & Sergio Santoro, 2008. "Optimal Monetary Policy When Agents Are Learning," 2008 Meeting Papers 679, Society for Economic Dynamics.
  5. Martin Fukac, 2006. "New Keynesian Model Dynamics under Heterogeneous Expectations and Adaptive Learning," Working Papers 2006/5, Czech National Bank, Research Department.
  6. Sergey Slobodyan & Atanas Christev, 2006. "On learnability of E–stable equilibria," Computing in Economics and Finance 2006 451, Society for Computational Economics.
  7. Michele Berardi, 2009. "Monetary Policy with Heterogeneous and Misspecified Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(1), pages 79-100, 02.

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