Expectations, learning and policy rule

Michele Berardi

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The University of Manchester

Abstract: The optimal discretionary policy rule in the New Keynesian forwardlooking model under the hypothesis of rational expectations responds only to fundamental shocks. This leads to indeterminacy of equilibria and E-unstability of the MSV REE. The outcome can be improved by responding to private expectations. This requires the Central Bank to be able to observe those expectations, or to precisely estimate them. It has also been shown in the literature that when the private sector doesn’t have RE and instead is trying to learn the structure of the economy from data, the policymaker should implement a more aggressive policy. In light of these considerations, we ask how a policymaker that responds only to fundamental shocks should change its response when private expectations depart from rationality. In addition, we show that a policy rule that adeguately takes into account the learning process of agents while responding only to fundamentals can obtain the same results as an expectations based policy rule.

Pages: 23 pages
Date: 2009
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:man:cgbcrp:112

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