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Inflation expectations and the transmission of monetary policy

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  • John M. Roberts

Abstract

New Keynesian models with sticky prices and rational expectations have a difficult time explaining why reducing inflation usually requires a recession. An explanation for the costliness of reducing inflation is that inflation expectations are less than perfectly rational. To explore this possibility, I estimate the degree of nonrationality implicit in two survey measures of inflation expectations. I find that the surveys reflect an intermediate degree of rationality: Expectations are nether perfectly rational nor as unsophisticated as simple autoregressive models would suggest. I also find that a structural New Keynesian model with expectations formation based on the survey results is able to match closely the empirical costs of reducing inflation.

Suggested Citation

  • John M. Roberts, 1998. "Inflation expectations and the transmission of monetary policy," Finance and Economics Discussion Series 1998-43, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:1998-43
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    File URL: http://www.federalreserve.gov/pubs/feds/1998/199843/199843abs.html
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    Keywords

    Inflation (Finance) ; Monetary policy;

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