This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

Imperfect knowledge, adaptive learning and the bias against activist monetary policies

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Alberto Locarno () (Banca d'Italia)

Additional information is available for the following registered author(s):

Abstract

When the economy is subject to recurrent structural shifts, the monetary authority cannot credibly commit to a systematic approach to policy, since consistency between promises and actions is not easily verifiable; moreover, since agents have incomplete knowledge of the surrounding environment, they form expectations that may deviate substantially from the full-information case. The present paper studies the implications for the effectiveness of discretionary monetary policymaking of departing from the benchmark of rational expectations and assuming instead that agents learn adaptively. It focuses on two issues, namely whether imperfect knowledge generates a bias against stabilisation policies and whether the optimal monetary strategy takes the form of an inflation cap. Rules featuring an inflation cap are not only justified on theoretical grounds, but are also appealing because they seem appropriate to deal with imperfect knowledge and learning: by setting explicit bounds on inflation, they seem better suited to restrain expectations from drifting significantly away from target, thus removing one of the main sources of policy ineffectiveness. The main findings of the paper are the following. First, when agents do not possess complete knowledge on the structure of the economy and rely on an adaptive learning technology, a bias toward conservativeness arises. Second, a policy that involves a cap on inflation is helpful in reducing output and inflation variability, but it is not uniformly superior to a strategy aimed at minimising a quadratic loss function. Third, the bias against stabilisation policies and towards conservativeness does not depend on whether agents have finite or infinite memory.

Download Info
To download:

If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td06/td590_06/td590/tema_590.pdf
File Format: application/pdf
File Function:
Download Restriction: no

Publisher Info
Paper provided by Bank of Italy, Economic Research Department in its series Temi di discussione (Economic working papers) with number 590.

Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Length:
Date of creation: May 2006
Date of revision:
Handle: RePEc:bdi:wptemi:td_590_06

Contact details of provider:
Postal: Via Nazionale, 91 - 00184 Roma
Web page: http://www.bancaditalia.it
More information through EDIRC

For technical questions regarding this item, or to correct its listing, contact: ().

Related research
Keywords: Adaptive learning; optimal degree of monetary policy discretion; bias against activist policies;

Other versions of this item:

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Working Papers in Applied Economic Theory 2002-04, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  2. Lars E.O. Svensson & Michael Woodford, 2000. "Indicator Variables for Optimal Policy," NBER Working Papers 7953, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Guiso, Luigi & Parigi, Giuseppe, 1996. "Investment and Demand Uncertainty," CEPR Discussion Papers 1497, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CEPR Discussion Papers 3811, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  5. Giuseppe Ferrero, 2004. "Monetary policy and the transition to rational expectations," Computing in Economics and Finance 2004 19, Society for Computational Economics. [Downloadable!]
    Other versions:
  6. Buiter, Willem H, 2006. "How Robust is the New Conventional Wisdom? The Surprising Fragility of the Theoretical Foundations of Inflation Targeting and Central Bank Independence," CEPR Discussion Papers 5772, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  7. Wiliam Branch & John Carlson & George W. Evans & Bruce McGough, 2004. "Monetary Policy, Endogenous Inattention, and the Volatility Trade-off," University of Oregon Economics Department Working Papers 2004-19, University of Oregon Economics Department, revised 15 May 2007. [Downloadable!]
    Other versions:
  8. Charles Goodhart & Margaret Bray, 2002. "You Might as Well be Hung for a Sheep as a Lamb: The Loss Function of an Agent," FMG Discussion Papers dp418, Financial Markets Group. [Downloadable!] (restricted)
  9. Evans, George W & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  10. S. Athey & A. Atkeson & P. Kehoe, 2003. "The optimal degree of monetary policy discretion," Proceedings, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Bray, Margaret, 1982. "Learning, estimation, and the stability of rational expectations," Journal of Economic Theory, Elsevier, vol. 26(2), pages 318-339, April. [Downloadable!] (restricted)
  12. Balvers, Ronald J & Cosimano, Thomas F, 1994. "Inflation Variability and Gradualist Monetary Policy," Review of Economic Studies, Blackwell Publishing, vol. 61(4), pages 721-38, October. [Downloadable!] (restricted)
  13. 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. [Downloadable!] (restricted)
  14. Livio Stracca & Ali Al-Nowaihi, 2002. "Non-standard Central Bank loss functions; skewed risks; and certainty equivalence," Working Paper Series 129, European Central Bank. [Downloadable!]
  15. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  16. Bertocchi, Graziella & Spagat, Michael, 1993. "Learning, experimentation, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 169-183, August. [Downloadable!] (restricted)
    Other versions:
  17. Driffill, John & Rotondi, Zeno, 2004. "Monetary Policy and Lexicographic Preference Ordering," CEPR Discussion Papers 4247, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  18. Niklas J. Westelius & Frederic S. Mishkin, 2006. "Inflation Band Targeting and Optimal Inflation Contracts," Hunter College Department of Economics Working Papers 416, Hunter College: Department of Economics. [Downloadable!]
    Other versions:
  19. Albert Marcet & Thomas J. Sargent, 1992. "Speed of Convergence of Recursive Least Squares Learning with ARMA Perceptions," Economics Working Papers 15, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  20. Corsetti, Giancarlo & Pericoli, Marcello & Sbracia, Massimo, 2005. "'Some contagion, some interdependence': More pitfalls in tests of financial contagion," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1177-1199, December. [Downloadable!] (restricted)
    Other versions:
  21. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August. [Downloadable!] (restricted)
    Other versions:
Full references

Statistics
Access and download statistics

Did you know? All top Economics journals are listed on RePEc.

This page was last updated on 2009-11-11.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.