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Expectations and the Stability Problem for Optimal Monetary Policies

  • George W. Evans

    ()

    (University of Oregon Economics Department)

  • Seppo Honkapohja

    (University of Helsinki)

A fundamentals based monetary policy rule, which would be the optimal monetary policy without commitment when private agents have perfectly rational expectations, is unstable if in fact these agents follow standard adaptive learning rules. This problem can be overcome if private expectations are observed and suitable incorporated into the policy maker's optimal rule. These strong results extend to the case in which there is simultaneous learning by the policy maker and the private agents. Our findings show the importance of conditioning policy appropriately, not just on fundamentals, but also directly on observed household and firm expectations.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2001-6.

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Length: 33
Date of creation: 03 Aug 2001
Date of revision: 03 Aug 2001
Handle: RePEc:ore:uoecwp:2001-6
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