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Expectations and optimal monetary policy: A stability problem revisited

Wei Xiao and Junyi Xu ()

Economics Letters, 2014, vol. 124, issue 2, 296-299

Abstract: A landmark result in the optimal monetary policy design literature is that fundamental-based interest rate rules invariably lead to rational expectations equilibria (REE) that are not stable under adaptive learning. In this paper, we make a novel information assumption that private agents cannot observe aggregate fundamental shocks, and use simple linear forecasting rules for learning. We find that with fundamental-based rules, there exist limited information equilibria that are stable under learning. Moreover, there are multiple equilibria. Learning can be used as a selection tool to identify a unique equilibrium.

Keywords: Adaptive learning; Optimal monetary policy; E-stability (search for similar items in EconPapers)
JEL-codes: C62 D84 E31 E37 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1016/j.econlet.2014.06.008

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