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Optimal Monetary Policy When Agents Are Learning

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  • Krisztina Molnár

    ()
    (Norwegian School of Economics and Business Administration, and Norges Bank (Central Bank of Norway))

  • Sergio Santoro

    ()
    (Bank of Italy)

Abstract

We derive the optimal monetary policy in a sticky price model when private agents follow adaptive learning. We show that this slight departure from rationality has important implications for policy design. The central bank faces a new intertemporal trade-off, not present under rational expectations: it is optimal to forego stabilizing the economy in the present in order to facilitate private sector learning and thus ease the future intratemporal inflation-output gap trade-offs. The policy recommendation is robust: the welfare loss entailed by the optimal policy under learning if the private sector actually has rational expectations is much smaller than if the central bank mistakenly assumes rational expectations when in fact agents are learning.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2010/WP-201008/
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Bibliographic Info

Paper provided by Norges Bank in its series Working Paper with number 2010/08.

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Length: 48 pages
Date of creation: 27 May 2010
Date of revision:
Handle: RePEc:bno:worpap:2010_08

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Keywords: optimal monetary policy; learning; rational expectations;

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References

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  1. Athanasios Orphanides & John C. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Working Paper Series 2003-24, Federal Reserve Bank of San Francisco.
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Citations

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Cited by:
  1. Martin Melecky & Diego Rodríguez Palenzuela & Ulf Söderström, 2008. "Inflation Target Transparency and the Macroeconomy," Working Papers Central Bank of Chile 490, Central Bank of Chile.
  2. Adam, Klaus & Marcet, Albert, 2011. "Internal rationality, imperfect market knowledge and asset prices," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1224-1252, May.
  3. Ichiro Muto, 2007. "Productivity Growth, Transparency, and Monetary Policy," IMES Discussion Paper Series 07-E-08, Institute for Monetary and Economic Studies, Bank of Japan.
  4. George W. Evans & Seppo Honkapohja, 2008. "Expectations, Learning, And Monetary Policy: An Overview Of Recent Research," Working Papers Central Bank of Chile 501, Central Bank of Chile.
  5. Alberto Locarno, 2012. "Monetary policy in a model with misspecified, heterogeneous and ever-changing expectations," Temi di discussione (Economic working papers) 888, Bank of Italy, Economic Research and International Relations Area.
  6. Christian Jensen, 2006. "Expectations, Learning, and Discretionary Policymaking," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
  7. repec:hal:cesptp:halshs-00609824 is not listed on IDEAS
  8. Adam, Klaus & Marcet, Albert, 2009. "Internal Rationality and Asset Prices," CEPR Discussion Papers 7498, C.E.P.R. Discussion Papers.
  9. 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.
  10. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.

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