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New Keynesian Model Dynamics under Heterogeneous Expectations and Adaptive Learning

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Martin Fukac

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Abstract

We analyze the economic dynamics in a basic New Keynesian model adjusted for imperfect, heterogeneous knowledge and adaptive learning. The policy, represented by a forward-looking Taylor rule, is driven by the central bank's own internal forecasts, whereas the core economic dynamics are driven by private agents' expectations. We study the implications of disagreement between those two. We find that if there is expectations heterogeneity, monetary policy should be less active in its actions in order to be short-run stability improving, and to affect positively the speed of convergence towards the first best equilibrium in the long run. This is in contrast to the homogeneous incomplete knowledge literature, which predicts the opposite. We also find that the homogeneous expectations economy is easier to operate in for monetary policy, and that policy can be more effective than in the heterogeneous expectations economy. From the perspective of incomplete, heterogeneous knowledge and adaptive learning methodology, we can thus see the importance of good communication policy and monetary policy credibility.

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Paper provided by Czech National Bank, Research Department in its series Working Papers with number 2006/5.

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Date of creation: Oct 2006
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Handle: RePEc:cnb:wpaper:2006/5

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Related research
Keywords: . Imperfect and heterogeneous knowledge adaptive learning monetary policy.

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis. [Downloadable!]
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  2. Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Mankiw, N. Gregory & Reis, Ricardo & Wolfers, Justin, 2003. "Disagreement about Inflation Expectations," Research Papers 1807, Stanford University, Graduate School of Business. [Downloadable!]
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  4. Giuseppe Ferrero, 2004. "Monetary policy and the transition to rational expectations," Computing in Economics and Finance 2004 19, Society for Computational Economics. [Downloadable!]
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  5. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  6. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February. [Downloadable!] (restricted)
  7. Kaushik Mitra & Seppo Honkapohja, 2004. "Performance of Monetary Policy with Internal Central Bank Forecasting," Royal Holloway, University of London: Discussion Papers in Economics 04/18, Department of Economics, Royal Holloway University of London, revised Jul 2004. [Downloadable!]
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  8. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA. [Downloadable!]
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  1. Kateřina Šmídková & Aleš Bulíř, 2007. "Striving to Be “Clearly Open” and “Crystal Clear”: Monetary Policy Communication of the CNB," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(11-12), pages 540-557, December. [Downloadable!]
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