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The Value of Interest Rate Stabilization Policies When Agents are Learning

  • John Duffy
  • Wei Xiao

We examine the expectational stability (E--stability) of rational expectations equilibrium in the ``New Keynesian\'\' model where monetary policy is optimally derived and interest rate stabilization is added to the central bank\'s traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja\'s (2003ab, 2006) findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.

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File URL: http://www.econ.pitt.edu/papers/John_jmcb05-164.pdf
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Paper provided by University of Pittsburgh, Department of Economics in its series Working Papers with number 284.

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Date of creation: Sep 2006
Date of revision: Oct 2006
Handle: RePEc:pit:wpaper:284
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  1. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  2. Honkapohja, S. & Mitra, K., 2001. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," University of Helsinki, Department of Economics 501, Department of Economics.
  3. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
  4. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Learning and the central bank," Working Paper 0117, Federal Reserve Bank of Cleveland.
  5. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  6. Berardi, Michele, 2008. "Should monetary policy respond to private sector expectations?," MPRA Paper 19285, University Library of Munich, Germany.
  7. Seppo Honkapohja & Kaushik Mitra & George W. Evans, 2011. "Notes on Agents¡¯ Behavioral Rules Under Adaptive Learning and Studies of Monetary Policy," CDMA Working Paper Series 201102, Centre for Dynamic Macroeconomic Analysis.
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