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Optimal Monetary Policy when Agents are Learning

  • Krisztina Molnár
  • Sergio Santoro

We derive the 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 the 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.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2010/wp-cesifo-2010-06/cesifo1_wp3072.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3072.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_3072
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  1. Sergey Slobodyan & Raf Wouters, 2009. "Learning in an Estimated Medium-Scale DSGE Model," CERGE-EI Working Papers wp396, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  2. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 807-824.
  3. A. Orphanides & J. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  9. Fabio Milani, 2006. "A Bayesian DSGE Model with Infinite-Horizon Learning: Do "Mechanical" Sources of Persistence Become Superfluous?," International Journal of Central Banking, International Journal of Central Banking, vol. 2(3), September.
  10. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  11. Gaspar, Vítor & Smets, Frank & Vestin, David, 2006. "Adaptive learning, persistence, and optimal monetary policy," Working Paper Series 0644, European Central Bank.
  12. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  13. Ferrero, Giuseppe, 2007. "Monetary policy, learning and the speed of convergence," Journal of Economic Dynamics and Control, Elsevier, vol. 31(9), pages 3006-3041, September.
  14. Benati, Luca, 2008. "Investigating inflation persistence across monetary regimes," Working Paper Series 0851, European Central Bank.
  15. F. Brayton & P. Tinsley, 1996. "A guide to FRB/US: a macroeconomic model of the United States," Finance and Economics Discussion Series 96-42, Board of Governors of the Federal Reserve System (U.S.).
  16. Argia M. Sbordone & Timothy Cogley, 2004. "A Search for a Structural Phillips Curve," Computing in Economics and Finance 2004 291, Society for Computational Economics.
  17. Wiliam Branch & George W. Evans, 2005. "A Simple Recursive Forecasting Model," University of Oregon Economics Department Working Papers 2005-3, University of Oregon Economics Department, revised 01 Feb 2005.
  18. Michael Woodford, 2007. "Interpreting Inflation Persistence: Comments on the Conference on "Quantitative Evidence on Price Determination"," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 203-210, 02.
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