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Monetary policy in a model with misspecified, heterogeneous and ever-changing expectations

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  • Alberto Locarno

    () (Bank of Italy)

Abstract

The applied literature on adaptive learning has mostly focused on small, linear models, with homogenous expectations. In non-linear models heterogeneous expectations prevail and the process through which agents select (and change) a forecasting model becomes a necessary ingredient of the analysis; moreover, the temporary equilibrium of the learning process approaches an asymptotic limit that may be affected by the communication strategies of the monetary policymaker. The objective of this paper is to assess whether in such a model economy the optimal monetary policy exhibits properties that are similar to those found in the literature for small, linear models. The main results are the following: (1) expectations heterogeneity is an intrinsic feature of the economy: no PLM succeeds in ruling out all the other forecasting models; (2) contrary to previous findings, the monetary policymaker has no incentive to adopt highly inflation-averse policies: too strong a reaction to price shocks increases both inflation and output volatility; (3) partial transparency seems to enhance somewhat welfare (but fully transparent policies do not); (4) a higher degree of transparency calls for stronger inflation aversion.

Suggested Citation

  • 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.
  • Handle: RePEc:bdi:wptemi:td_888_12
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    bounded rationality; generalised stochastic gradient learning; transparency.;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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