Inflation Scares and Forecast-Based Monetary Policy

Athanasios Orphanides and John Williams

No 4844, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Central bankers frequently emphasize the critical importance of anchoring private inflation expectations for successful monetary policy and macroeconomic stabilization. In most monetary policy models, however, expectations are already anchored through the assumption of rational expectations and perfect knowledge of the economy. In this Paper, we re-examine the role of inflation expectations by positing, instead, that agents have imperfect knowledge of the precise structure of the economy and policy-makers' preferences, and rely on a perpetual learning technology to form expectations. We find that with learning, disturbances can give rise to endogenous inflation scares, that is, significant and persistent deviations of inflation expectations from those implied by rational expectations, even at long horizons. The presence of learning increases the sensitivity of inflation expectations and the term structure of interest rates to economic shocks, in line with the empirical evidence. We also explore the role of private inflation expectations for the conduct of efficient monetary policy. Under rational expectations, inflation expectations equal a linear combination of macroeconomic variables and as such provide no additional information to the policy-maker. In contrast, under learning, private inflation expectations follow a time-varying process and provide useful information for the conduct of monetary policy.

Keywords: Inflation forecasts; Policy rules; Rational expectations; Learning (search for similar items in EconPapers)
JEL-codes: E52 (search for similar items in EconPapers)
Date: 2005-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (115)

Downloads: (external link)
https://cepr.org/publications/DP4844 (application/pdf)

Related works:
Journal Article: Inflation scares and forecast-based monetary policy (2005)
Working Paper: Inflation scares and forecast-based monetary policy (2003)
Working Paper: Inflation Scares and Forecast-Based Monetary Policy (2003)
Working Paper: Inflation scares and forecast-based monetary policy (2003)
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:cpr:ceprdp:4844

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP4844

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().