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Optimal Monetary Policy under Heterogeneous Expectations

  • Orlando Gomes

    (Escola Superior de Comunicação Social)

Monetary policy has an important role in the determination of the inflation rate and the output gap time trajectories. Monetary authorities should choose the nominal interest rate time path that best serves the goals of price stability (primarily) and output growth (as a consequence of the first). In this paper it is presented a framework under which an optimal interest rate rule is computed, and this rule is found to be stabilizing. The stability result is true for a homogeneous expectations scenario, where all individuals believe that inflation converges to a long run low level. Introducing expectations heterogeneity under a bounded rationality – discrete choice setup, this result continues to hold, but now we cannot exclude periods of strong price instability that, nevertheless, do not tend to persist for long periods of time.

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Paper provided by EconWPA in its series Macroeconomics with number 0409023.

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Length: 32 pages
Date of creation: 28 Sep 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0409023
Note: Type of Document - pdf; pages: 32
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