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The Value of Interest Rate Stabilization Policies When Agents are Learning

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  • John Duffy
  • Wei Xiao

Abstract

We examine the expectational stability (E--stability) of rational expectations equilibrium in the ``New Keynesian\'\' model where monetary policy is optimally derived and interest rate stabilization is added to the central bank\'s traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja\'s (2003ab, 2006) findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.

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Bibliographic Info

Paper provided by University of Pittsburgh, Department of Economics in its series Working Papers with number 284.

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Date of creation: Sep 2006
Date of revision: Oct 2006
Handle: RePEc:pit:wpaper:284

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  1. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  2. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
  3. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Learning and the central bank," Working Paper 0117, Federal Reserve Bank of Cleveland.
  4. Honkapohja, S. & Mitra, K., 2001. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," University of Helsinki, Department of Economics 501, Department of Economics.
  5. Berardi, Michele, 2008. "Should monetary policy respond to private sector expectations?," MPRA Paper 19285, University Library of Munich, Germany.
  6. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
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Cited by:
  1. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076 Central Bank of Chile.
  2. Evans , George W & Honkapohja, Seppo, 2007. "Robust learning stability with operational monetary policy rules," Research Discussion Papers 31/2007, Bank of Finland.
  3. Llosa, Luis-Gonzalo & Tuesta, Vicente, 2009. "Learning about monetary policy rules when the cost-channel matters," Journal of Economic Dynamics and Control, Elsevier, vol. 33(11), pages 1880-1896, November.
  4. Eric Gaus, 2013. "Robust Stability of Monetary Policy Rules under Adaptive Learning," Southern Economic Journal, Southern Economic Association, vol. 80(2), pages 439-453, October.
  5. Emanuel Gasteiger, 2013. "Heterogeneous Expectations, Optimal Monetary Policy, and the Merit of Policy Inertia," CDMA Working Paper Series 201308, Centre for Dynamic Macroeconomic Analysis.
  6. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  7. Eric Gaus, 2013. "Time-Varying Parameters and Endogenous Learning Algorithms," Working Papers 13-02, Ursinus College, Department of Economics.

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