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Learning about Monetary Policy Rules when Long-Horizon Expectations Matter

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  • Preston, Bruce

Abstract

This paper considers the implications of an important source of model misspecification for the design of monetary policy rules: the assumed manner of expectations formation. In the model considered here, private agents seek to maximize their objectives subject to standard constraints and the restriction of using an econometric model to make inferences about future uncertainty. Because agents solve a multiperiod decision problem, their actions depend on forecasts of macroeconomic conditions many periods into the future, unlike the analysis of Bullard and Mitra (2002) and Evans and Honkapohja (2002). A Taylor rule ensures convergence to the rational expectations equilibrium associated with this policy if the so-called Taylor principle is satisfied. This suggests the Taylor rule to be desirable from the point of view of eliminating instability due to self-fulfilling expectations.

Suggested Citation

  • Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:830
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    File URL: https://mpra.ub.uni-muenchen.de/830/1/MPRA_paper_830.pdf
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    References listed on IDEAS

    as
    1. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-1322, December.
    2. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    3. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
    4. James Bullard & Kaushik Mitra, 2007. "Determinacy, Learnability, and Monetary Policy Inertia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1177-1212, August.
    5. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
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    More about this item

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G0 - Financial Economics - - General

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