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Optimal Monetary Policy under Adaptive Learning

Author

Listed:
  • Vitor Gaspar

    (Banco de Portugal)

  • Frank Smets

    (European Central Bank)

  • David Vestin

    (European Central Bank)

Abstract

We consider optimal policy when private sector expectations are formed through adaptive learning. Earlier research has found that adaptive learning is consistent with empirical evidence on private sector expectations. In this paper, we consider the (admittedly) extreme case of sophisticated central banking, whereby the central bank has full knowledge about the structure of the economy. Our results confirm that the management of inflation expectations is crucial for the conduct of monetary policy. n particular, when the private sector perceives that inflation persistence is high, optimal policy responds strongly to lagged inflation and inflation shocks thereby stabilizing inflation and anchoring inflation expectations. For our parametrization it does so at no cost for output gap stability

Suggested Citation

  • Vitor Gaspar & Frank Smets & David Vestin, 2006. "Optimal Monetary Policy under Adaptive Learning," Computing in Economics and Finance 2006 183, Society for Computational Economics.
  • Handle: RePEc:sce:scecfa:183
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    File URL: http://repec.org/sce2006/up.17883.1140458209.pdf
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    Cited by:

    1. Maritta Paloviita, 2008. "Comparing alternative Phillips curve specifications: European results with survey-based expectations," Applied Economics, Taylor & Francis Journals, vol. 40(17), pages 2259-2270.
    2. Michael Woodford, 2010. "Robustly Optimal Monetary Policy with Near-Rational Expectations," American Economic Review, American Economic Association, vol. 100(1), pages 274-303, March.
    3. Mele, Antonio & Molnar, Krisztina & Santoro, Sergio, 2014. "On the perils of stabilizing prices when agents are learning," Discussion Paper Series in Economics 1/2015, Norwegian School of Economics, Department of Economics.
    4. Orphanides, Athanasios & Williams, John C., 2008. "Learning, expectations formation, and the pitfalls of optimal control monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages 80-96, October.
    5. Volker Wieland, 2009. "Learning, Endogenous Indexation, and Disinflation in the New-Keynesian Model," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 11, pages 413-450 Central Bank of Chile.
    6. Martin Melecký & Diego Rodríguez Palenzuela & Ulf Söderström, 2009. "Inflation Target Transparency and the Macroeconomy," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 10, pages 371-411 Central Bank of Chile.
    7. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive Learning, Persistence, and Optimal Monetary Policy," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 376-385, 04-05.
    8. Dennis, Richard & Ravenna, Federico, 2008. "Learning and optimal monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(6), pages 1964-1994, June.
    9. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076 Central Bank of Chile.
    10. Kevin Lansing, 2009. "Time Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 304-326, April.
    11. Smets, Frank & Vestin, David & Gaspar, Ví­tor, 2007. "Is time ripe for price level path stability?," Working Paper Series 818, European Central Bank.
    12. Loisel, Olivier, 2008. "Central bank reputation in a forward-looking model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3718-3742, November.
    13. Ernest Gnan & Mar Gudmundsson & Klaus Liebscher & Dietrich Domanski & Alexandra Heath & Juan Delgado & Walter Boltz & Birger Vikoren & Vasily Astrov & Stephan Barisitz & Simon-Erik Ollus & Ulrich Kohl, 2008. "Commodities, Energy and Finance," SUERF Studies, SUERF - The European Money and Finance Forum, number 2008/2 edited by Ernest Gnan & Mar Gudmundsson & Morten Balling.
    14. Ulrich Kohli, 2008. "Energy prices, inflation, and monetary policy," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum.
    15. Christian Jensen, 2006. "Expectations, Learning, and Discretionary Policymaking," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.

    More about this item

    Keywords

    Optimal Policy; Adaptive Learning; Rational Expectations; Policy Rules;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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