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Deflationary vs. Inflationary Expectations - A New-Keynesian Perspective with Heterogeneous Agents and Monetary Believes

We expand a standard New-Keynesian model by allowing for a special role of money in the inflation and expectations building process. Motivated by the two-pillar Phillips curve, we introduce heterogeneous expectations. Thereby a fraction of agents forms inflation expectations by observing trend money growth. We show that in the presence of these monetary believers, contractive shocks to the economy produce smoother dynamics for inflation and output. We also find that monetary policy should follow a conventional Taylor rule with contemporaneous inflation and output data, if it is uncertain about the fraction of monetary believers.

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Paper provided by Department of Economics, University of Hohenheim, Germany in its series Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim with number 312/2009.

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Length: 34 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:hoh:hohdip:312
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