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Heterogeneous Expectations, Adaptive Learning,and Forward-Looking Monetary Policy

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In this paper, I examine the role of monetary policy in a heterogeneous expectations environment. I use a New Keynesian business cycle model as the experiment laboratory. I assume that the central bank and private economic agents (households and producing rms) have imperfect and heterogeneous information about the economy, and as a consequence, they disagree in their views on its future development. I facilitate the heterogeneous environment by assuming that all agents learn adaptively. Measured by the central bank's expected loss, the two major findings are: (i) policy that is efcient under homogeneous expectations is not effccient under heterogeneous expectations; (ii) in the short and medium run, policy that is excessively responsive to ination increases ination and output volatility, but in the long run such policy lowers economic volatility.

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File URL: http://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Discussion%20papers/2008/dp08-07.pdf
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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2008/07.

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Length: 24 p.
Date of creation: May 2008
Handle: RePEc:nzb:nzbdps:2008/07
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  1. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2003. "Disagreement about Inflation Expectations," NBER Working Papers 9796, National Bureau of Economic Research, Inc.
  2. Athanasios Orphanides & John C. Williams, 2003. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Working Papers 9884, National Bureau of Economic Research, Inc.
  3. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
  4. Frederic S. Miskin & Klaus Schmidt-Hebbel, 2007. "Does Inflation Targeting Make a Difference?," Central Banking, Analysis, and Economic Policies Book Series, in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 9, pages 291-372 Central Bank of Chile.
  5. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series 0127, European Central Bank.
  6. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
  7. 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.
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