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The Value of Interest Rate Stabilization Policies When Agents Are Learning

  • JOHN DUFFY
  • WEI XIAO

We examine the expectational stability (E-stability) of rational expectations equilibrium in the "New Keynesian" model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective. Copyright 2007 The Ohio State University.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1538-4616.2007.00097.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 39 (2007)
Issue (Month): 8 (December)
Pages: 2041-2056

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Handle: RePEc:mcb:jmoncb:v:39:y:2007:i:8:p:2041-2056
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  1. Berardi, Michele, 2008. "Should monetary policy respond to private sector expectations?," MPRA Paper 19285, University Library of Munich, Germany.
  2. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
  3. Carlstrom, Charles T. & Fuerst, Timothy S., 2004. "Learning and the central bank," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 327-338, March.
  4. 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.
  5. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  6. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  7. Seppo Honkapohja & Kaushik Mitra & George W. Evans, 2011. "Notes on Agents¡¯ Behavioral Rules Under Adaptive Learning and Studies of Monetary Policy," CDMA Working Paper Series 201102, Centre for Dynamic Macroeconomic Analysis.
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