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Expectations and the effects of monetary policy

  • Laurence Ball
  • Dean Croushore

This paper examines the predictive power of shifts in monetary policy, as measured by changes in the real federal funds rate, for output, inflation, and survey expectations of these variables. We find that policy shifts have larger effects on actual output than on expected output; thus, policy predicts errors in output expectations, a violation of rational expectations. Policy shifts do not predict errors in inflation expectations. We explain these results with a model in which agents systematically underestimate the effects of policy on aggregate demand. This model helps to explain the real effects of policy.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 95-22.

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Date of creation: 1995
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Handle: RePEc:fip:fedpwp:95-22
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