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The value of interest rate stabilization polices when agents are learning

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Author Info

  • 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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References

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  1. Kaushik Mitra & Seppo Honkapohja, 2004. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Royal Holloway, University of London: Discussion Papers in Economics 04/13, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  2. Berardi, Michele, 2008. "Should monetary policy respond to private sector expectations?," MPRA Paper 19285, University Library of Munich, Germany.
  3. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  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. Honkapohja, Seppo & Evans, George W., 2000. "Expectations and the stability problem for optimal monetary policies," Discussion Paper Series 1: Economic Studies 2000,10, Deutsche Bundesbank, Research Centre.
  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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Citations

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Cited by:
  1. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  2. Evans, George W & Honkapohja, Seppo, 2008. "Robust Learning Stability with Operational Monetary Policy Rules," CEPR Discussion Papers 6641, C.E.P.R. Discussion Papers.
  3. Evans , George W & Honkapohja, Seppo, 2007. "Expectations, learning and monetary policy: an overview of recent research," Research Discussion Papers 32/2007, Bank of Finland.
  4. Eric Gaus, 2013. "Time-Varying Parameters and Endogenous Learning Algorithms," Working Papers 13-02, Ursinus College, Department of Economics.
  5. 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.
  6. 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.
  7. Emanuel Gasteiger, 2013. "Heterogeneous Expectations, Optimal Monetary Policy, and the Merit of Policy Inertia," CDMA Working Paper Series 201308, Centre for Dynamic Macroeconomic Analysis.

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