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Optimal monetary policy when agents are learning

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  • Molnár, Krisztina
  • Santoro, Sergio

Abstract

We derive optimal monetary policy in a sticky price model when private agents follow adaptive learning. We show that this slight departure from rationality has important implications for policy design. The central bank faces a new intertemporal trade-off, not present under rational expectations: it is optimal to forego stabilizing the economy in the present in order to facilitate private sector learning and thus ease the future intratemporal inflation-output gap trade-offs. The policy recommendation is robust: the welfare loss entailed by optimal policy under learning if the private sector actually has rational expectations is much smaller than if the central bank mistakenly assumes rational expectations when in fact agents are learning.

Suggested Citation

  • Molnár, Krisztina & Santoro, Sergio, 2014. "Optimal monetary policy when agents are learning," European Economic Review, Elsevier, vol. 66(C), pages 39-62.
  • Handle: RePEc:eee:eecrev:v:66:y:2014:i:c:p:39-62
    DOI: 10.1016/j.euroecorev.2013.08.012
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    Cited by:

    1. Gaël Giraud & Nguenamadji Orntangar, 2011. "Monetary policy under finite speed of trades and myopia," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00609824, HAL.
    2. Martin Melecký & Diego Rodríguez Palenzuela & Ulf Söderström, 2009. "Inflation Target Transparency and the Macroeconomy," 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 10, pages 371-411 Central Bank of Chile.
    3. Adam, Klaus & Marcet, Albert, 2011. "Internal rationality, imperfect market knowledge and asset prices," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1224-1252, May.
    4. 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.
    5. Muto, Ichiro, 2013. "Productivity growth, transparency, and monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 329-344.
    6. Bask, Mikael & Proaño, Christian R., 2016. "Optimal monetary policy under learning and structural uncertainty in a New Keynesian model with a cost channel and inflation inertia," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 112-126.
    7. Mele, Antonio & Molnar, Krisztina & Santoro, Sergio, 2014. "On the perils of stabilizing prices when agents are learning," Discussion Paper Series in Economics 1/2015, Norwegian School of Economics, Department of Economics.
    8. Alberto Locarno, 2012. "Monetary policy in a model with misspecified, heterogeneous and ever-changing expectations," Temi di discussione (Economic working papers) 888, Bank of Italy, Economic Research and International Relations Area.
    9. Favaretto, Federico & Masciandaro, Donato, 2016. "Doves, hawks and pigeons: Behavioral monetary policy and interest rate inertia," Journal of Financial Stability, Elsevier, vol. 27(C), pages 50-58.
    10. Eusepi, Stefano & Giannoni, Marc & Preston, Bruce, 2012. "Long-Term Debt Pricing and Monetary Policy Transmission under Imperfect Knowledge," CEPR Discussion Papers 8845, C.E.P.R. Discussion Papers.
    11. Michele Berardi, 2009. "Monetary Policy with Heterogeneous and Misspecified Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(1), pages 79-100, February.
    12. Caprioli, Francesco, 2015. "Optimal fiscal policy under learning," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 101-124.
    13. André, Marine Charlotte & Dai, Meixing, 2017. "Is central bank conservatism desirable under learning?," Economic Modelling, Elsevier, vol. 60(C), pages 281-296.
    14. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.
    15. Ali, Syed Zahid & Anwar, Sajid, 2017. "Exchange rate pass through, cost channel to monetary policy transmission, adaptive learning, and the price puzzle," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 69-82.
    16. Michele Berard, 2006. "Monetary policy with heterogeneous and misspecified expectations," The School of Economics Discussion Paper Series 0637, Economics, The University of Manchester.
    17. Christian Matthes, 2015. "Figuring Out the Fed—Beliefs about Policymakers and Gains from Transparency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(1), pages 1-29, February.
    18. Adam, Klaus & Marcet, Albert, 2009. "Internal Rationality and Asset Prices," CEPR Discussion Papers 7498, C.E.P.R. Discussion Papers.
    19. Christian Jensen, 2006. "Expectations, Learning, and Discretionary Policymaking," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.

    More about this item

    Keywords

    Optimal monetary policy; Learning; Rational expectations;

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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