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Inflation Expectations, Adaptive Learning and Optimal Monetary Policy

In: Handbook of Monetary Economics

Author

Listed:
  • Gaspar, Vitor
  • Smets, Frank
  • Vestin, David

Abstract

This chapter investigates the implications of adaptive learning in the private sector's formation of inflation expectations for the conduct of monetary policy. We first review the literature that studies the implications of adaptive learning processes for macroeconomic dynamics under various monetary policy rules. We then analyze optimal monetary policy in the standard New Keynesian model, when the central bank minimizes an explicit loss function and has full information about the structure of the economy, including the precise mechanism generating private sector's expectations. The focus on optimal policy allows us to investigate how and to what extent a change in the assumption of how agents form their inflation expectations affects the principles of optimal monetary policy. It also provides a benchmark to evaluate simple policy rules. We find that departures from rational expectations increase the potential for instability in the economy, strengthening the importance of anchoring inflation expectations. We also find that the simple commitment rule under rational expectations is robust when expectations are formed in line with adaptive learning.

Suggested Citation

  • Gaspar, Vitor & Smets, Frank & Vestin, David, 2010. "Inflation Expectations, Adaptive Learning and Optimal Monetary Policy," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 19, pages 1055-1095 Elsevier.
  • Handle: RePEc:eee:monchp:3-19
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    Citations

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    Cited by:

    1. Sophocles N. Brissimis & Petros M. Migiakis, 2016. "Inflation persistence, learning dynamics and the rationality of inflation expectations," Empirical Economics, Springer, vol. 51(3), pages 963-979, November.
    2. Yan Carriere-Swallow & Bertrand Gruss & Nicolas E Magud & Fabian Valencia, 2016. "Monetary Policy Credibility and Exchange Rate Pass-Through," IMF Working Papers 16/240, International Monetary Fund.
    3. André, Marine Charlotte & Dai, Meixing, 2017. "Is central bank conservatism desirable under learning?," Economic Modelling, Elsevier, vol. 60(C), pages 281-296.
    4. Julian A. Parra-Polania & Luisa F. Acuña-Roa, 2013. "Price-Level Targeting: an omelette that requires breaking some Inflation-Targeting eggs?," BORRADORES DE ECONOMIA 010984, BANCO DE LA REPÚBLICA.
    5. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828 Elsevier.

    More about this item

    Keywords

    Adaptive Learning; Optimal Monetary Policy; Policy Rules; Rational Expectations;

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General

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