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Learning, inflation expectations and optimal monetary policy

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Author Info
Eric Schaling (Department of Economics, RAU)

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Abstract

In this paper we analyse disinflation policy in two environments. In the first, the central bank has perfect knowledge, in the sense that it understands and observes the process by which private sector inflation expectations are generated; in the second, the central bank has to learn the private sector inflation forecasting rule. With imperfect knowledge, results depend on the learning scheme that is employed. Here, the learning scheme we investigate is that of least-squares learning (recursive OLS) using the Kalman filter. A novel feature of a learning- based policy – as against the central bank’s disinflation policy under perfect knowledge – is that the degree of monetary accommodation (the extent to which the central bank accommodates private sector inflation expectations) is no longer constant across the disinflation, but becomes state-dependent. This means that the central bank’s behaviour changes during the disinflation as it collects more information.

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Paper provided by EconWPA in its series Macroeconomics with number 0404035.

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Date of creation: 29 Apr 2004
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Handle: RePEc:wpa:wuwpma:0404035

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Related research
Keywords: learning; rational expectations; separation principle; Kalman filter; time-varying parameters; optimal control;

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Find related papers by JEL classification:
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Marcet, Albert & Sargent, Thomas J, 1988. "The Fate of Systems with "Adaptive" Expectations," American Economic Review, American Economic Association, vol. 78(2), pages 168-72, May. [Downloadable!] (restricted)
  2. James B. Bullard, 1991. "Learning, rational expectations and policy: a summary of recent research," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 50-60. [Downloadable!]
  3. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March. [Downloadable!] (restricted)
  4. Andolfatto, David & Scott Hendry & Kevin Moran, 2002. "Inflation Expectations and Learning about Monetary Policy," Working Papers 02-30, Bank of Canada. [Downloadable!]
    Other versions:
  5. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August. [Downloadable!] (restricted)
    Other versions:
  6. Bertocchi, Graziella & Spagat, Michael, 1991. "Learning, Experimentation and Monetary Policy," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1991018, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
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  7. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-22, December. [Downloadable!] (restricted)
  8. Eric Schaling, . "The non-linear Phillips curve and inflation forecast targeting," Bank of England working papers 98, Bank of England. [Downloadable!]
  9. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August. [Downloadable!] (restricted)
  10. Kiefer, Nicholas M & Nyarko, Yaw, 1989. "Optimal Control of an Unknown Linear Process with Learning," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 571-86, August. [Downloadable!] (restricted)
  11. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mewael Tesfaselassie & Eric Schaling & Sylvester Eijffinger, 2004. "Heterogeneous Information about the Term Structure of Interest Rates, Least-Squares Learning and Optimal Interest Rate Rules for Inflation Forecast Targeting," Econometric Society 2004 North American Summer Meetings 78, Econometric Society. [Downloadable!]
    Other versions:
  2. Ruthira Naraidoo & Rangan Gupta, 2009. "Modelling monetary policy in South Africa: Focus on inflation targeting era using a simple learning rule," Working Papers 200904, University of Pretoria, Department of Economics. [Downloadable!]
  3. Schaling , Eric & Eijffinger , Sylvester & Tesfaselassie , Mewael, 2004. "Heterogeneous information about the term structure, least-squares learning and optimal rules for inflation targeting," Research Discussion Papers 23/2004, Bank of Finland. [Downloadable!]
  4. Vauhkonen, Jukka, 2003. "Are adverse selection models of debt robust to changes in market structure?," Research Discussion Papers 28/2003, Bank of Finland. [Downloadable!]
  5. Eijffinger, Sylvester C W & Schaling, Eric & Tesfaselassie, Mewael F., 2004. "Heterogenous Information About the Term Structure of Interest Rates, Least-Squares Learning and Optimal Interest Rate Rules," CEPR Discussion Papers 4279, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  6. Llewellyn, David T. & Mayes , David G., 2003. "The role of market discipline in handling problem banks," Research Discussion Papers 21/2003, Bank of Finland. [Downloadable!]
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  7. Orlando Gomes & Vivaldo M. Mendes & Diana A. Mendes, 2007. "The Dynamics of Learning in Optimal Monetary Policy," Working Papers ercwp2008, ISCTE, UNIDE, Economics Research Centre. [Downloadable!]
  8. Kauko, Karlo, 2003. "Interlinking securities settlement systems: A strategic commitment?," Research Discussion Papers 26/2003, Bank of Finland. [Downloadable!]
  9. Mewael F. Tesfaselassie, 2008. "Central Bank Learning and Monetary Policy," Kiel Working Papers 1444, Kiel Institute for the World Economy. [Downloadable!]
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