PRECAUTIONARY LEARNING AND INFLATIONARY BIASES

Chetan Dave and James Feigenbaum

Macroeconomic Dynamics, 2020, vol. 24, issue 5, 1124-1150

Abstract: In a canonical monetary policy model in which the central bank learns about underlying fundamentals by estimating the parameters of a Phillips curve, we show that the bank’s loss function is asymmetric such that parameter overestimates may be more or less costly than underestimates, creating a precautionary motive in estimation. This motive suggests the use of a more efficient variance-adjusted least-squares estimator for learning about fundamentals. Informed by this “precautionary learning” the central bank sets low inflation targets, and the economy can settle near a Ramsey equilibrium.

Date: 2020
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Working Paper: Precautionary Learning and Inflationary Biases (2007)
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