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The value of interest rate stabilization polices when agents are learning

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  • Duffy, John

    (University of Pittsburgh)

  • Xiao, Wei

    (University of New Orleans)

Abstract

We examine the expectational stability (E—stability) of rational expectations equilibrium under optimal interest rate rules in the context of the standard, “New Keynesian” model of the monetary transmission mechanism. We focus on the case where the monetary authority adds interest rate stabilization to its other objectives of inflation and output stabilization. We consider both the case where the monetary authority lacks a commitment technology and as well as the case of full commitment. We show that for both cases, optimal interest rate rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. This finding stands in contrast to the findings of Evans and Honkapohja (2002, 2003ab) for optimal monetary policy rules in environments where interest rate stabilization is not part of the central bank’s objective function.

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Bibliographic Info

Paper provided by University of New Orleans, Department of Economics and Finance in its series Working Papers with number 2004-02.

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Length: 17 pages
Date of creation: Jun 2004
Date of revision:
Handle: RePEc:uno:wpaper:2004-02

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Keywords: Expectational stability (E-stability); Rational expectations equilibrium; Monetary transmission mechanism;

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  1. 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.
  2. Honkapohja, Seppo & Mitra, Kaushik, 2004. "Are non-fundamental equilibria learnable in models of monetary policy?," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1743-1770, November.
  3. Berardi, Michele, 2008. "Should monetary policy respond to private sector expectations?," MPRA Paper 19285, University Library of Munich, Germany.
  4. Carlstrom, Charles T. & Fuerst, Timothy S., 2004. "Learning and the central bank," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 327-338, March.
  5. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  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. 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.
  3. George W. Evans & Seppo Honkapohja, 2008. "Robust Learning Stability with Operational Monetary Policy Rules," Working Papers Central Bank of Chile 504, Central Bank of Chile.
  4. Eric Gaus, 2012. "Robust Stability of Monetary Policy Rules under Adaptive Learning," Working Papers 13-01, Ursinus College, Department of Economics, revised 14 Dec 2012.
  5. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  6. Emanuel Gasteiger, 2013. "Heterogeneous Expectations, Optimal Monetary Policy, and the Merit of Policy Inertia," CDMA Working Paper Series 201308, Centre for Dynamic Macroeconomic Analysis.
  7. Eric Gaus, 2013. "Time-Varying Parameters and Endogenous Learning Algorithms," Working Papers 13-02, Ursinus College, Department of Economics.

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