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Expectations and the Stability Problem for Optimal Monetary Policies

Author

Listed:
  • George W. Evans

    (University of Oregon Economics Department)

  • Seppo Honkapohja

    (University of Helsinki)

Abstract

A fundamentals based monetary policy rule, which would be the optimal monetary policy without commitment when private agents have perfectly rational expectations, is unstable if in fact these agents follow standard adaptive learning rules. This problem can be overcome if private expectations are observed and suitable incorporated into the policy maker's optimal rule. These strong results extend to the case in which there is simultaneous learning by the policy maker and the private agents. Our findings show the importance of conditioning policy appropriately, not just on fundamentals, but also directly on observed household and firm expectations.

Suggested Citation

  • George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
    • Handle: RePEc:ore:uoecwp:2001-6
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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