Optimal monetary policy in a New Keynesian model with heterogeneous expectations

Giovanni Di Bartolomeo (), Marco Di Pietro () and Bianca Giannini

No 54, Dynare Working Papers from CEPREMAP

Abstract: In a world where expectations are heterogeneous, what is the design of the optimal policy? Are canonical policies robust when heterogeneous expectations are considered or would they be associated with large welfare losses? We aim to answer these questions in a stylized simple New Keynesian model where agents’beliefs are not homogeneous. Assuming that a fraction of agents can form their expectations by some adaptive or extrapolative schemes, we focus on an optimal monetary policy by second-order approximation of the policy objective from the consumers’utility function. We find that the introduction of bounded rationality in the New Keynesian framework matters. The presence of heterogeneous agents adds a new dimension to the central bank’s optimization problem— consumption inequality. Optimal policies must be designed to stabilize the cross-variability of heterogeneous expectations. In fact, as long as different individual consumption plans depend on different expectation paths, a central bank aiming to reduce consumption inequality should minimize the cross-sectional variability of expectations. Moreover, the traditional trade-off between the price dispersion and aggregate consumption variability is also quantitatively affected by heterogeneity.

Keywords: monetary policy; bounded rationality; heterogeneous expectations (search for similar items in EconPapers)
JEL-codes: E24 E52 E58 J51 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2020-02
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.dynare.org/wp-repo/dynarewp054.pdf Main text (application/pdf)

Related works:
Journal Article: Optimal monetary policy in a New Keynesian model with heterogeneous expectations (2016)
Working Paper: Optimal monetary policy in a New Keynesian model with heterogeneous expectations (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpm:dynare:054

Access Statistics for this paper

More papers in Dynare Working Papers from CEPREMAP Contact information at EDIRC.
Bibliographic data for series maintained by Sébastien Villemot ().