Optimal normalization policy under behavioral expectations

Alexandre Carrier and Kostas(Konstantinos) Mavromatis

Journal of Monetary Economics, 2025, vol. 153, issue C

Abstract: We characterize optimal normalization policy in a framework in which agents’ expectations can deviate from the rational expectations benchmark and the central bank faces cost-push shocks. When interest rate fluctuations are costless, our findings indicate that the interest rate is the primary tool for managing inflationary pressures, consistently outperforming balance sheet adjustments, regardless of the expectations formation process. However, under de-anchored expectations, an increasing role for balance sheet management arises when interest rate fluctuations become costly. Finally, our analysis reveals that expectations significantly influence the optimal interest rate trajectory, whereas their impact on the optimal balance sheet path is comparatively minimal.

Keywords: Optimal monetary policy; De-anchored expectations; Normalization strategy (search for similar items in EconPapers)
JEL-codes: D84 E52 E71 (search for similar items in EconPapers)
Date: 2025
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Working Paper: Optimal normalization policy under behavioral expectations (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:153:y:2025:i:c:s0304393225000571

DOI: 10.1016/j.jmoneco.2025.103786

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