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Optimal Monetary Policy under Adaptive Learning

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  • Vitor Gaspar

    (Banco de Portugal)

  • Frank Smets

    (European Central Bank)

  • David Vestin

    (European Central Bank)

Abstract

We consider optimal policy when private sector expectations are formed through adaptive learning. Earlier research has found that adaptive learning is consistent with empirical evidence on private sector expectations. In this paper, we consider the (admittedly) extreme case of sophisticated central banking, whereby the central bank has full knowledge about the structure of the economy. Our results confirm that the management of inflation expectations is crucial for the conduct of monetary policy. n particular, when the private sector perceives that inflation persistence is high, optimal policy responds strongly to lagged inflation and inflation shocks thereby stabilizing inflation and anchoring inflation expectations. For our parametrization it does so at no cost for output gap stability

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 183.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:183

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Keywords: Optimal Policy; Adaptive Learning; Rational Expectations; Policy Rules;

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