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Monetary Policy, Endogenous Inattention, and the Volatility Trade-off

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Author Info

  • William Branch

    ()
    (Economics University of California, Irvine)

  • John Carlson
  • George W. Evans
  • Bruce McGough

Abstract

This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the `Great Moderation' that began in the 1980's

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 106.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:106

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Keywords: optimal policy; expectations; adaptive learning;

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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.
  2. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
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  6. Athanasios Orphanides & John Williams, 2004. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Chapters, in: The Inflation-Targeting Debate, pages 201-246 National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Evans, George & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," SIRE Discussion Papers 2008-03, Scottish Institute for Research in Economics (SIRE).
  2. Pfajfar, D., 2012. "Formation of Rationally Heterogeneous Expectations," Discussion Paper 2012-083, Tilburg University, Center for Economic Research.
  3. George W. Evans & William A. Branch, 2005. "Model Uncertainty and Endogenous Volatility," Computing in Economics and Finance 2005 33, Society for Computational Economics.
  4. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," NBER Working Papers 8290, National Bureau of Economic Research, Inc.
  5. Wiliam Branch & John Carlson & George W. Evans & Bruce McGough, 2006. "Adaptive Learning, Endogenous Inattention, and Changes in Monetary Policy," University of Oregon Economics Department Working Papers 2006-6, University of Oregon Economics Department.
  6. Lena Dräger, 2011. "Endogenous Persistence with Recursive Inattentiveness," KOF Working papers 11-285, KOF Swiss Economic Institute, ETH Zurich.
  7. Ricardo Reis, 2009. "Optimal Monetary Policy Rules in an Estimated Sticky-Information Model," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(2), pages 1-28, July.
  8. Alberto Locarno, 2007. "Imperfect Knowledge, Adaptive Learning, and the Bias Against Activist Monetary Policies," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 47-85, September.
  9. Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.

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